It has a great "Whoosh! Soon-it'll-all-be-gone" sound. To say nothing of an "I'm taking charge!" sound. These days we get bombarded with ads from companies saying that for no fee they'll consolidate all our debt. What, actually, does that mean?
Here's how, under ideal conditions, it works. (More about the less-than-ideal conditions later.) A company -- which usually offers both "credit counseling" and "debt consolidation" services -- goes over all your expenses with you and decides what you can afford to pay, TOTAL, per month toward your debts. Then they negotiate with all your creditors (this only works for UNSECURED debt, not car loans and mortgages), getting down your "minimum" payments and even lowering your interest rates. One company online claims it can "achieve" the following rates "instead of the usual 18 percent to 20 percent: Chase Manhattan 9 percent, Citibank 8 percent, Bank of New York 6 percent, Bank of America 0 percent (that's right, zero percent interest!)."
Thus they can claim they're saving you money, since the overall amount you'll have to pay to get rid of that $4,500 Visa debt is less, if you're paying a lower interest rate and putting more per month toward the principal. And indeed they are, although you might be able to get the same deals yourself if you're a smart wheeler-dealer. But let's say you have them do it for you. They will also make the payments to your various creditors each month, while you only have to bother yourself with writing out one check: to them.
Now, down to the nitty-gritty. Why are these lovely nonprofit companies being so nice to you? Because they get paid to do it. By whom? By the creditors. Oh ho. Now the plot thickens. The reason there's been such an enormous upswing of these businesses is the woeful credit situation in this country. Creditors have so much outstanding debt and so many people defaulting on their payments (and bankruptcy -- at this point, at least -- is relatively easy), they know they stand to lose an awful lot of money if they don't bend.
The nonprofit companies are essentially functioning as double-service middlemen. They're doing the collecting for the creditors, and they're also negotiating for you. As for the credit-card companies, they pay the non-profit companies in the form of "contributions" and thus are able to create great tax write-offs for themselves, thereby offsetting some of the loss they incur in reducing their staggering rates.
Final advantage for you? Once you've set up such a program, the creditors are supposed to stop calling you. Your counseling or debt management company is supposed to deal with them. So you see, under ideal conditions, it can be a win-win-win situation. Everyone gets something out of it -- the debt management or consumer counseling company (it's all the same thing), the usurious creditor who's been crippling you with its ridiculously high rates and now will just make a decent profit off you, and you. So what's to worry about?
Let's talk about less-than-ideal conditions. Here are some promises none of these companies can keep and shouldn't be offering and are signs to you to run fast in the other direction:
- "We'll repair your credit history." Bogus claim. Your history is your history, and no one can make it otherwise.
- "We'll give you a new 'credit identity.' " This is illegal, but it's done. They basically get you a false Social Security number so you can start getting credit cards again. Fraud, in a word.
- "You pay us up front, then we perform." Run, run, run.
Under the Credit Repair Organization Act, credit repair companies cannot require you to pay until they have completed the promised service. The truth? No one can legally remove accurate and timely negative information from a credit report. But if there's wrong information in your file, you can dispute it as inaccurate or incomplete, and there's no charge for doing this: Ask the credit reporting agency for a dispute form and submit your dispute in writing, along with copies of any supporting information.
In short, you can do all this yourself for nothing, or you can hire someone to do it for you. If you hire someone, be sure to get a written contract in which they spell out exactly what they're going to do for you.
If you've been victimized by one of these organizations, laws are in place to protect you. Talk to your state attorney general. Many attorneys general have toll-free consumer hotlines.
One last caveat on debt consolidation. Mortgage companies try to market second mortgages by advising you to "consolidate your debt" with the money from a second mortgage on your house. In other words, you use the nice big chunk of second mortgage money to pay off all those credit cards. Then you just pay the mortgage payment every month.
Nothing illegal here, just foolish. First of all, you're still borrowing money and still paying interest. Second, you've given over all the equity in your house. That equity is a big nest egg for most people -- the biggest asset they'll ever have. So don't toss it away until you've investigated other possibilities.
Bottom line: It's probably better to live with your debt by negotiating lower interest and minimum payments, then paying MORE than the minimum and getting the principal paid off faster.