Other Ways To Deal With Debt - The Downside

Every year...millions of Americans drawn upon a variety of mechanisms to help deal with debt. Unfortunately, each one of these mechanisms has its downside. As the popularity of theses mechanisms has increased, so have the dangers.

Here are links to some of those mechanisms:

(1) RE-MORTGAGING YOUR HOME:

It used to be...decades ago....at least in some States....that you were only allowed to have 1 mortgage on your home. The clear benefit of this was that you could not use the value in your home as a source of money to dip into. This being the case....the result was that....for a lot of people....paying on the mortgage meant paying off on their home so that....when they reached retirement....their home was paid for and....at a time when their income would naturally be diminished, they would correspondingly have no mortgage payment to contend with.

But....then along came the "home equity" loan. As the name implies....it became legal to dip in the value of your home. The good news was that...in an emergency....you could dip into the value in your home to pay for other things. However...you could only dip into the value of your home to the degree that there was value in your home above what was owed on your first mortgage (in North Carolina....this is called a Deed of Trust). The downside was that....for a vast number of Americans....unable or unwilling to leave this equity alone, it spelled the end of paying off the mortgage....the end of using the accumulating equity in their homes as a way to save money.

And then....as things progressed....as the safeguards of decades past eroded.....it became legal to not only dip into the equity of your home, but it became legal to pledge your home for loans far in excess of the value of the home. One example of this....you may have heard of....is the so-called "125% mortgage"....where you could now get a loan of up to 1 and 1/4 the value of your home.

The biggest problem of all this is that....in your being able to access the value in your home....is that you also give your creditors access to your home. In order to take money out of your home....you have to pledge your home as collateral for the loan. The creditor is said to acquire a "lien" on your home, and.....very simply....this means that if you can't afford to make your payments on the loan....the creditor can take you home through a mechanism called "foreclosure", and there may not be anything you can do about it.....except....in some circumstances....for filing a Chapter 13 bankruptcy case to save the home.

These loans....secured by your home... may seem like a nice "quick fix" to help deal mounting "unsecured" debt, but....much of the time....they are nothing more than a trap that you willingly jump into....and which leave you worse off. You take out the loan to get other bills paid for.....but what you may not realize is that you are signing on to making payments for sometimes vastly longer periods of time....many times 10 to 30 years worth of payments. In the final analysis....you end up exactly where the creditors want you....paying interest forever on loans that never end.

Perhaps as bad...is the fact that....by using one of these mortgages to pay off your credit cards or other unsecured debts.....you are turning simple, unsecured debts....dischargeable in bankruptcy....into debts that can only be gotten rid of by agreeing to give up your home. What a shame!

These loans are often attractive to consumers because they usually offer low interest rates and lower monthly payments, but the total amount of all the payments....paid out over 10 to 30 years....can add up to a sum that is 3, 4, 5 or 6 times the original amount borrowed. Oftentimes...these loans are "sold" based upon how much you save each month....and completely leaving out the fact that you will still be paying payments years after you would otherwise have been done....at a time when likely you will be too old to work or have much less income.

Many times....these "home" loans involve "adjustable" interest rates.....and as interest rates rise...so does your monthly payment.....and this can turn the "quick fix" into a total disaster.

Many of these loans also include a lot of more or less hidden costs.....most of which get added into the total amount due....costs like "points", "origination fees", appraisal fees, title insurance, attorney fees, etc., etc. These loans can quickly turn into truly "predatory" loans backed with very extra charges like expensive credit life and disability insurance.

Other problems include "teaser rates" and "balloon payments". A "teaser rate" is a low introductory interest rate that can (and usually does) increase during the term of the loan, sometimes by several percent, drastically increasing the total cost of the loan. A "balloon payment" requires the borrower to pay off the entire amount of the loan after a set period of years. This results in your having to borrow even more money and pay even more fees....and this is assuming that when your loan "balloons" you even have good enough credit to "refinance" your loan. If not....it's foreclosure time....and you lose your home.

More and more people are ending up in a position where they owe more on their home than it is worth....making home ownership seem more like a 30 year lease from which there is no escape.....except for filing bankruptcy.

If you are desperate enough to borrow more money that you have to pledge your home as collateral.....you may well be a good candidate for filing bankruptcy instead. Results will vary depending upon your particular circumstances....but the advantage of bankruptcy is that bankruptcy can get rid of simple, unsecured debts....without your having to pledge your home as collateral.

(2) 401-K LOANS:

Many people work for companies or organizations that provide for a retirement plan. Many....if not most....of these retirement plans are set up in accordance with section 401-K of the tax code. Thus the name "401K Plan". Unfortunately for many people....these plans allow you to borrow against the funds accumulated. The problems are manifold: First....you are borrowing against your own retirement....borrowing against a time when you will need the money most. Second...by law....your employer must make you pay it back. This cuts into your monthly income...income needed to take care of your family. Third....if you don't pay the money back...as where you lose your job...or having changed jobs, you dip further into these monies, you get penalized severely...under the tax code....for doing so. Fourth....by taking out one of these loans to pay off credit cards or other unsecured debts....you are....in effect....pledging your retirement funds as collateral...and in doing so...paying off simple, unsecured.....and dischargeable debts....with money that is secured by your retirement plan.

If you are desperate enough to borrow from your 401K plan....you are probably a good candidate for filing bankruptcy. The advantage of bankruptcy is that bankruptcy can get rid of simple unsecured debts....without putting your retirement funds at risk. Why? Because funds in a retirement plan...like a 401K plan...are protected under the law.

(3) CREDIT CARD BALANCE TRANSFERS:

"Balance transfer" is where you use money borrowed against a new credit card to pay off the balance on an old one. Companies that try to get you to use their credit card to pay off the balance on another company's credit card usually advertise a dramatically-reduced "introductory" interest rate. This is usually just a trap for the unwary. Acquiring additional credit cards is rarely the answer for managing your debt. Much of the time...it just exacerbates your problem. First off....many people keep their existing "paid off" credit card accounts open..... which entices them to incur even more debt.

A balance transfer ignores the root of the problem....which is....insufficient income to manage existing debt. In contrast, Chapter 7 and Chapter 13 bankruptcies are effective because they address the cause of peoples' financial problems by eliminating or reducing the total amount of debt.

The pitfalls of balance transfers are usually found in the small print. Low introductory interest rates are used to lure you into transferring your balances onto other credit cards, and often seem so appealing that the hidden costs and fees are hard to find and easy to overlook. The low interest rate usually lasts for only a limited amount of time. At the end of that period..... the introductory interest rate rises, sometimes to a higher rate than that of the original credit card. The low introductory rate period is often cancelled if the borrower makes any late payments on the account. The interest rate offered may only be applicable to balance transfers, and a different interest rate is often applied to all new cash advances and purchases. Usually.....payments made will be applied to the lower balance first......leaving the balances with the higher interest rates continuing to rack up interest.

The costs involved with a balance transfer can quickly cancel out any financial gain from a low introductory interest rate. Common fees include monthly finance fees, annual fees, balance transfer fees, cash advance fees, over-the-limit fees and convenience check fees. Borrowers often end up paying more in fees than the amount they are saving with the lower interest rate. The lenders also frequently push expensive add-ons and profit boosters, like credit protection insurance.....which can cost as much as $45 a month. The fee is often charged up front.....meaning the borrower is required to pay the interest each month on the extra amount.
In addition....frequent balance transfers can damage your credit score. The increased activity can make you appear to be a credit risk, and having too many active accounts can also damage your credit score.

So, think twice before transferring balances from one credit card to another. Examine all of your options and speak with your attorney before making a financial decision that could have long-term detrimental implications.

The bottom line is that if you have more credit card debt than you can pay....you are probably a good candidate for bankruptcy. Unlike balance transfers....bankruptcy can get rid of credit card debt....once and for all. Results will vary...depending upon your particular circumstances.

(4) DEBT CONSOLIDATION LOANS THROUGH A BANK OR FINANCE COMPANY:

Debt consolidation loans are personal loans that allow people to consolidate their debt into one monthly payment. The payments are often lower because the loan is spread out over a much longer period of time. Although the monthly payment may be lower, the true cost of the loan is often dramatically increased when the additional costs and interest over the term of the loan are factored in.

The interest rates on personal debt consolidation loans are usually high, especially for people with financial problems. Lenders frequently target people in vulnerable situations with troubled credit by offering what appears to be an easy solution. Most of the time....these are the so-called "finance" companies.

Personal debt consolidation loans can be either secured or unsecured. Unsecured loans are made based upon a promise to pay.....while secured loans require collateral. Upon default of the loan payment in a secured loan, the creditor has a right to repossess any of the items listed as collateral for the loan. One example is where you agree to allow the creditor to use your car or truck as collateral. Depending upon the State you live in...the creditor will either hold your title or place a "lien" on your title. With this type of loan....you have to pay off the loan to either re-acquire your title or to get the lien on your title released. If you don't pay....the creditor can "repossess" your vehicle....which means the creditor can take it and sell it.

Some creditors require you to list household goods in order to obtain a debt consolidation loan. Think about it. The creditor doesn't really want this stuff...but the creditor lists your household good anyway because the creditor knows you want the stuff and....because you want the stuff...you will be more likely to make your loan payments on time. In many States....if you don't pay....the creditor has a right to repossess your household goods. In many States, a person filing bankruptcy can remove the lien on the household goods listed as collateral and still eliminate the debt.

Be careful about putting up your valued property as collateral. With high interest rates and aggressive collections....you could well find yourself worse off and scrambling to save your car, truck or other personal property.

(5) CREDIT-COUNSELING REPAYMENT PLANS:

What are Credit Counseling Repayment Plans? Very simply....in most cases....these are basically repayment plans set up by agencies that are just collection agencies for the credit card companies. The thing is that they package themselves in a way to make it look like they are working for you....and for FREE. Such is not the case.

What can they do for me? At most....they will help you lower your interest rates a little, and then usually only with respect to credit cards....and then only with respect to credit cards with companies that are willing to participate. If what you really need is to get rid of some debt....Credit Counseling Agencies are of no use whatsoever. Only bankruptcy can actually get rid of debt. Is it any wonder that credit counseling agencies hate bankruptcy. They work for the credit card companies....and the credit card companies know that the one thing that can "unhook" you from their control is bankruptcy.

What to know more....a lot more about the downside of credit counseling? See the sub-topic on this website under the heading called "Alternatives to Bankruptcy".
 

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