With suddenly-rising unemployment rates and many households turning to credit cards to pay living expenses, the need for consolidating credit card debts will increase throughout 2020 and beyond. The best debt consolidation options during and after the coronavirus pandemic include do-it-yourself repayment plans, debt management programs through nonprofit credit counseling agencies, and, in cases of well-established consumer discipline, debt consolidation loans.
While the pandemic has not led to any new debt consolidation options – private, nonprofit, government or otherwise – the social, economic, and household financial chaos it has produced has increased the importance in consumers’ minds of eliminating debt and doing so as quickly, efficiently, and cost-effectively as possible. Consolidating debts can refer to the consolidation of multiple debt balances into a single account or to the consolidation of multiple monthly debt payments into a single monthly payment.
However, debt consolidation will never mean the same thing as debt reduction. Consolidation is a process, while reduction is a direction.
Debt Consolidation Remains a Vague Term
Whether during times of financial crises and natural disasters or when the national and world economies experience consistent growth, the term “debt consolidation” paints only a vague and incomplete picture in the minds of consumers struggling to find help with their debts. To the consumer, the term mostly represents the simplification of his or her debt repayment strategy.
Debt consolidation allows the consumer to focus on one payment rather than many. Debt consolidation does not mean the consumer’s interest rates will decrease, or even that the consumer’s debt balances will decrease. Whether the interest rates and balances increase or decrease will depend entirely on which consolation method the consumer chooses.
The following debt consolidation options appear to be the most affordable, most appropriate, and generally most helpful first, while the most damaging and expensive comes last.
· Do-It-Yourself Debt Consolidation
While not technically a debt consolidation plan, the do-it-yourself method feels like a debt consolidation option and offers the simplification of your monthly debt payments. To do this on your own, start by considering the day of the month on which you could most afford to pay your debts. With mortgages, rents, and many subscription bills due at the beginning of each month, many consumers find choosing a debt payment date during the second half of the month most appropriate and effective.
Next, contact each of your creditors to request a change to your payment due date, as previously identified. Note that you will generally have no success requesting a creditor move a due date from one month to the next (e.g., from the 27th of this month to the 8th of next month). Most, however, will work with you if you ask them to move the payment due date back in the month, especially if you have made your payments on time for the past year or more.
Finally, set up automated payments of your debts to take the stress out of remembering when and how to make the payment. You can choose from two types of automated payments: online bill pay or direct debit.
· Online Bill Pay
You can set up online bill pay through your own checking account, usually through your bank’s or credit union’s app or online portal. Simply add a new payee (your creditor) with the corresponding address, payment date, and payment amount.
As this method often relies on sending payment by mail, you should allow plenty of flexibility when identifying the payment due date. If, for example, you owe the payment on the 20th of the month, you might have to schedule the payment to go out on the 10th. Even then, if the payment arrives late, the creditor will hold you responsible for possible late fees, not the postal service or your bank.
The main drawback of this method involves the limitations of the payment amount. For credit cards whose balances change monthly, this method may not fit your needs since it requires you to establish a set monthly payment.
· Direct Debit
Setting up a direct debit payment involves adding your checking account information (account and routing numbers) to your creditors’ payment portals. Then, each month, your creditors will pull the payment directly from your checking account. You can choose a set payment amount, the minimum payment (rarely recommended), or the full balance.
The beauty of this method involves both its ease and the shifting of the payment responsibility from you to the creditor. If the creditor does not pull the payment on the due date (and this happens from time to time), they cannot hold you responsible for a late fee. Of course, if the creditor attempts to pull the payment from your account and finds the funds insufficient, they will likely charge you an insufficient funds fee.
As neither of these methods involves changes to your monthly payment due, creditors generally have no problems with the arrangements. You can consolidate (automate) your payments for your credit cards, mortgage, car or truck payment, student loans, and even old utility bills or cell phone accounts. If you owe child support, you might as well include that too, for simplicity’s sake.
· Debt Shuffles
If setting up multiple, automated payments for your debts does not fit your goals, your next consideration might involve what we call a “debt shuffle.” Debt shuffles move your debts from multiple accounts into one new account. They are true consolidations, but they can give a false impression of progress against your debt.
The two common forms of debt shuffles involve transferring the balances of your debts to a single credit card or paying them off with the help of your home equity. Neither option, though, does much for actually helping you pay down your debts. Debt shuffles act much the same as a bandage on a wound. They treat the symptoms, not the causes. In fact, if the debts originated from excessive consumer spending, using either of these options could actually backfire and leave you with twice the debt you started with.
· Credit Card Balance Transfers
Credit card companies often purchase mailing lists from the consumer reporting agencies (also known as credit bureaus) to find potential customers. If your credit background meets their specifications, you will receive an offer from them to transfer the balances from your other credit cards onto a new credit card.
These offers often come with lower or 0% interest rates, making them attractive offers. Keep in mind that the offer does not guarantee approval. Many consumers assume the transfer will go through and might even choose not to make further payments on the other accounts. If the credit card company denies the transfer offer or even delays it, the consumer has missed payments on the other accounts and will have to deal with additional late fees.
Even worse, if you consider transferring debts from other credit cards that you incurred due to overspending, you might fall into the trap of seeing your formerly-maxed-out cards now sitting there with zero balances. This happens to far too many consumers. If you believe a credit card balance transfer will offer you the benefits of consolidation, make sure you address the reason you got into debt in the first. Otherwise, you might find yourself among the 70% of consumers who run up their old credit cards to the same levels where they were prior to consolidation, leaving them with twice the original debt within just two years.
However, if you believe you have already addressed and remedied the reasons for your debts, a credit card balance transfer can offer you an affordable and convenient solution to your financial troubles. Most credit card companies will allow you to use the approved balance transfer offer to pay off other credit card debts, medical debts, collection accounts, and even some home or car loans.
· Home Equity or Line of Credit
Home equity loans and home equity lines of credit (HELOCs) offer the same solutions and dangers as the credit card balance transfers described above. However, because these options secure the new account through the equity in your home (the amount of your home’s value that surpasses your current mortgage balance), they require the borrower to go through a more extensive application process.
Additionally, home equity loans and HELOCs present much greater risks to the borrower. If he or she does not make future payments as agreed, the lender has legal rights to foreclose on the borrower’s home.
· Debt Management Programs through Nonprofit Credit Counseling Agencies
If you have considered the previous debt consolidation options, but feel they will not work for you, you should take your next step by calling a nonprofit credit counseling agency (CCA) to discuss whether a debt management program makes sense for your situation.
Nonprofit credit counseling has existed pretty much since the creation of credit cards in the mid-twentieth century. For generations, credit counseling agencies have existed to help consumers who struggle with overwhelming debts. The free services offered by nonprofit credit counseling agencies include budgeting guidance and assistance as well as credit report reviews and analyses.
Additionally, CCAs offer debt management programs (DMP) through which your creditors agree to lower (an even eliminate in a few cases) their interest rates and stop charging late and over-limit fees. While this service comes with some heavily regulated and capped fees, your total monthly payment will still typically amount to less than your current payment, not to mention that you will pay off your debts in five years or less.
While you can include all credit card debts, most collection accounts, medical bills, old utility and cell phone debts, and even old back taxes in a debt management program, you cannot include secured debts such as mortgages, vehicle loans, and most business loans. Although you cannot get any better interest rates on your student loans through a CCA, you can still generally include it in the single, monthly consolidated DMP payment to simplify your finances.
· Debt Consolidation Loans
Debt consolidation loans seem to offer the perfect solution to many consumers struggling with their debts. However, what appears a blessing can end up a double curse if the consumer does address the reasons he or she has incurred their overwhelming debt.
Debt consolidation loans are personal loans the consumer applies for, requesting the new lender to pay off some or all his or her current debts, after which the consumer will make a single monthly payment to the new lender. The problem with consolidation loans is they address the symptoms and not the causes of debts. Like the previously-noted example of placing a bandage on a wound, using a consolidation loan makes you feel like you are doing something helpful when, in fact, the problem will likely increase in intensity and negative consequences.
Consider the example of a consumer-facing overwhelming debt due to regularly overspending on credit cards. If he or she pays off their credit cards with a new consolidation loan, it might appear as though the situation has improved when, in reality, its potential for financial ruin has actually increased. Back in the 2000s, a creditor study found that 70% of consumers who used a consolidation loan or credit card balance transfer to pay off their debts had run their previously-paid off cards back up to their original balances within one to two years.
If your debt was caused by medical issues or from other challenges that you have already addressed, you might consider the benefits of a consolidation loan. However, the next challenge of consolidation loans involves the difficulties in qualifying for them. Additionally, most debt consolidation lenders charge relatively high interest rates because of the risk they incur in the process. Finally, other lenders refuse to approve consolidation loans for consumers with poor credit ratings. Debt consolidation loans can help consumers take care of multiple accounts, including credit cards, medical debts, collections, and even car loans. Besides traditional lenders (banks and credit unions), social lending platforms like LendingClub.com and Prosper.com offer personal loans consumers can use to consolidate their various debts into a single account. Expect interest rates to run the gamut from 8% or 10% on the low end to 30% or more on the upper end, with the average APR in the 18% to 20% range.