Three Kinds of Debt Consolidation

There are three methods of debt consolidation:

1. Debt Consolidation Loan – For individuals with credit in good standing the most common form of debt consolidation is the combining of all outstanding debts into one loan simply called a debt consolidation loan.

2. Home Equity Line – The longer an individual remains in their home the more equity they accrue. Prior to the housing market crash the average increase of an individual’s home value was approximately 6.3% over the past 45 years. The market value of their home becomes greater than their purchase price. This increase in market value plus the payments already made on the principal of the loan create the equity in your home. Due to this increase in the home value banks allow individuals to withdraw money as a line of credit against their home. All lenders develop a maximum credit line a homeowner may borrow through their home equity line. The lender develops this credit limit by calculating a percentage of the home’s appraised value as the main variable.  An example of the calculation follows:

Example: Johnny purchased a home in 2003 for $150,000. His home appraised in 2006 at $200,000. He now wants to obtain cash by borrowing from his home equity line.  The bank will allow up to 50% of the home’s appraised value as a the home equity line. Additionally, Johnny owes $30,000 on his mortgage. The cash available to Johnny is calculated as follows:

  • Home Appraised Value: $200,000
  • Banks Maximum %: 50%
  • % of Appraised Value Johnny is able to borrower: $100,000
  • Amount Johnny owes on home: $ 30,000
  • Johnny’s available funds to borrower: $ 70,000

3. Debt repayment plan through credit counseling:

The third and final option is the engaging of a credit counselor to help consolidate your bills, create a monthly budget, develop a payment plan that helps you pay off your debt within a specified period of time (this use variables such as outstanding debt and annual interest rates), and acting as an intermediary between you and the credit card companies, banks, and/or other lenders.

  • A borrower should be aware that a when a reputable credit counseling company contacts your borrower they usually have the ability to lower your annual interest rate between 5% to 15%.  However, when a credit counselor contacts a lending institution the lender normally reports you to the credit bureau. The credit bureau flags this on your credit report and other lenders may not approve loans to you until you have completed the credit counseling program.
  • Credit Counseling Agencies are great resources if you are an individual who needs guidance to control your spending habits, are unable to negotiate a lower annual interest rate on your outstanding debt, are unaware of how to create a budget, or just need help developing a debt removal plan to pay off your debt.  If you have the resources to do this on your own it is best to try prior to choosing this option.

The best option is to reach out to a lender who will loan you the money under the condition they pay off all your outstanding debts in arrears (i.e. credit cards, mortgages, car payments, etc.).  Through this type of loan/debt consolidation the lender will assume all your debt .   This will halt any further decline in your FICO Score.  Additionally, the lender normally charges a lower  interest rate per month than a bank, credit card company, or any other debtor.  The lender has the ability to do this because he/she is obtaining all your debt and receiving interest on a higher balance.

Example: Johnny’s outstanding debt is:

  • American Express $15,000 at 25% per month
  • Visa $5,000 at 15% per month
  • mortgage $50,000 at 5% per month
  • car payment is $10,000 at 10% per month.

As of today Johnny is currently paying $8,000 in interest per month on all his debts.  Johnny, who has fallen into financial distress due to extenuating circumstances, can still make a timely monthly payment under debt consolidation.  Thus, he may be offered a consolidation loan from a lender at 8% per month.  As a result, Johnny will pay $6,400 per month in interest instead of the original $8,000 in interest on the $80,000 of outstanding debt.  Johnny will save $19,200 in interest payments per year.

  • Share/Save/Bookmark