Today we will look closely at what has become one of the most widely used methods of consolidating and eliminating credit card debt and unsecured debt:  Home equity loans and refinancing.  This can be a smart decision for some, allowing them to save lots of money on interest and pay the debt off at a much lower interest rate.  However, there are a couple of major pitfalls that you will need to avoid if you consolidate your unsecured debt and credit cards in this way.

Turning Unsecured Debt into Secured Debt

Credit card debt, medical bills, personal loans, and many other debts that people commonly pay off with home equity loans are unsecured debts.  This means that there is no collateral on these debts.  If you fail to meet your payment obligations on these types of accounts, your creditors cannot simply foreclose on your home or repossess your car like they could on secured accounts. 

For example, your mortgage loan is secured by your home, and your car usually serves as the collateral that secures your auto loan.  So when you default on your mortgage, the bank can foreclose on your home, and when you default on your car loan, the bank can repossess your car.  In fact, it is relatively easy for the bank to pursue those options when you do not make your payments.

When you default on your credit cards and other unsecured debts, there is no simple, easy way for your creditors to collect because there is no collateral that the creditors have a right to take.  To pursue any collection method other than calling you and asking you to pay, the creditor would have to take you to court and get a judgment against you.  Even then, it is very unlikely that you would be losing your home or car over an unpaid credit card.

When you consolidate your credit cards (and any other unsecured debt) using the equity in your home, you are essentially converting these unsecured debts into a debt that is now secured by your home.  Your house now serves as collateral on this debt. 

Now, if something happens and you are unable to make your payments, you are putting your home at risk, and the bank now has a claim to your house. 

Most people feel that they will be able to make their payments, so this is not an issue for them.  However, very few people consider the very real possibility of an unforeseen event causing them to default on their debt payments.  What if any of the following were to happen to you?  Would you still be able to meet your obligations?  What if:

• You or your spouse are laid off or fired?  Most people think it cannot happen to them, but millions of people lose their jobs every year.
• You have an accident and are temporarily or permanently disabled?  No one likes to think about such things, but it does happen.  If you or your spouse become disabled and are unable to work, even temporarily, could you still make all of your payments?
• Someone becomes severely ill?  Again, this is something we do not like to consider.  Still, if you, or your spouse becomes severely ill, could you still afford your current lifestyle?  What if you are unable to work?  What about the cost of medical care that may be necessary? 
• Other unexpected expenses occur?  With suddenly skyrocketing gas prices and inflation in food on living expenses, many people are experiencing financial troubles right now.  What if other unexpected expenses occur?  Many people consolidate their debt because money is tight, but if you are already close to the edge, it will not take much to push you over.  One unexpected expense or a rise in living expenses could be too much for you to handle.

These are just some of the things you will want to consider before using your home equity to pay off your unsecured debts.  Still, using your home equity as a means of unsecured credit card debt consolidation can be the right choice for some, provided you carefully evaluate your situation.

To further confuse matters, many companies advertising under the guise of “debt consolidation” or even “credit card consolidation” are actually offering totally different services or products!  A quick search on google will probably leave the average consumer’s head spinning. 

If you are looking for information or help with unsecured debt, how are you supposed to make sense of all this?  Well that’s why we are here, so today we will explain some of the different options for consolidating your credit cards and unsecured debt.

1.  Home Equity Loans.  Home equity loans use the equity that you have in your home as collateral, generally allowing you to obtain a relatively low interest rate loan.  Many people use these loans to consolidate credit cards and other unsecured debts.  You must own a home, have equity, and have a relatively good credit score and credit history for this debt consolidation option to be available to you.

2.  Refinancing.  This option is very similar to the home equity loan option just discussed.  With refinancing, you actually take out a new mortgage on your home which pays off the remaining balance of your old mortgage.  Many people refinance to take advantage of better terms such as lower interest rates. 

If you have equity in your home when you refinance, you may have the option of “cashing out” and taking cash, which will be rolled into your new mortgage balance.  Many people use this cash to pay off high interest credit card debt. 

 As with the home equity loan, you must have solid credit and equity in a home to pursue this option for getting out of debt.  Refinancing typically gets you a lower interest rate than a home equity loan; however, fees can be substantial and refinancing is generally harder to do.

3.  Unsecured or Debt Consolidation Loans.  For people who cannot, or do not wish to, obtain a home equity loan (or refinance), an unsecured debt consolidation loan may be an option.  These loans, also known as personal or signature loans, generally have much higher interest rates than home equity loans because they are not secured by any collateral.  Still, depending on your situation, they may have better rates than your credit cards.  In order to take advantage of this debt solution, you generally need a pretty good credit score. 

4.  Debt Settlement.  Debt settlement is probably the most controversial option for dealing with unsecured credit card debt. This is mostly due to the fact that, although many debt settlement companies advertise as a “debt consolidation” service, many people feel that it is not, in fact, a form of debt consolidation. 

Without making any judgments, we will just say that using the services of a debt settlement company usually involves making monthly payments to the settlement company.  These funds are usually held by the settlement company until you have saved enough to settle your debts and to pay the company’s fee.  Then, the debt settlement company will attempt to reach an agreement with your creditors to pay a percentage of the debt that you now owe, and agree that you have no further obligation to the creditor for the settled account. 

Debt settlement is probably not generally an attractive option for people with good or fair credit ratings, or for consumers whose debt is still held by the original creditors.  For the consumer whose accounts are all in the hands of collection agencies, debt settlement MAY be helpful, but we would advise careful consideration of all factors (although we generally would never recommend a debt settlement, for reasons we will cover in depth in a future article). 

5.  Debt Management Plans or Credit Counseling.  Another somewhat controversial credit card consolidation option is a debt management plan, also commonly referred to as “consumer credit counseling” or just “credit counseling.”  Despite much misleading and inaccurate information, credit counseling can be a helpful option for debt consolidation for many people struggling with credit card debt. 

For those who are behind on their credit card bills, over their credit limits, or are struggling with high interest rates or steep monthly payments, credit counseling could be their saving grace.  In a debt management plan, a credit counselor works with your creditors to get you lower interest rates, get rid of late fees and over the limit fees, and helps you get your account back to current status.  In many cases, a debt management plan can lower your monthly payments as well as help you pay off your debt much, much faster. 

Still, credit counseling is not for everyone:  those with already super low interest rates or those who can easily pay off their credit cards on their own very quickly should not seek the aid of a debt management plan.  For those who do choose credit counseling, seeking a reputable agency is key.  This topic will also be covered in much more depth in future articles.

6.  Banktruptcy.  The dreaded final option.  Bankruptcy also gets a bad name by those who abuse it as a way to get out of paying their debt, by attorneys who try to convince nearly everyone to file, and by those who feel it is irresponsible and the ultimate shame.  The truth is, bankruptcy is a good last resort for those who truly need it and have exhausted all other options.

Certainly, you should try all reasonable solutions before deciding to file bankruptcy.  However, in certain cases, people truly have no other option or means to pay off their debt.  While filing for bankruptcy does have negative consequences, it is not the end of the world.  In fact, bankruptcy is designed to be somewhat of a clean slate for people who have no other recourse. 

Unfortunately, many people believe that filing for bankruptcy means you will lose your home or car, or that you will never be able to obtain credit again.  Fortunately, these beliefs are mostly false. 

Hopefully you now have a better idea of how these 6 most common debt consolidation options work, as well as which options are most likely to be helpful to you.  These topics will all be covered in much more depth in future articles, as each is much too complex to be discussed fully in this article.  Remember, if you are beginning to struggle with any kind of debt, whether it is your mortgage, car loan, credit cards, medical bills, or anything else, it is important to get help quickly before you run out of options.  Still, it is important to do your research, be cautious, and find reputable and trustworthy sources for information, particularly when it comes to the often controversial topics of unsecured credit card debt consolidation.