How Does Debt Consolidation Work? Pros and Cons

When people feel overwhelmed by credit card payments or other debt, they may turn to creative solutions other than bankruptcy to address the problem. A common tactic is to consolidate the debt into one payment. Debt consolidation is complicated, so knowing how it works and its pros and cons before pursuing it is crucial.

Debt consolidation starts with debtors working with a debt consolidation agency or applying for a consolidation loan from a bank. Each option has pros and cons, which our lawyers can prepare you for when overseeing your case. In general, debt consolidation works by grouping your debt into one monthly payment, potentially lowering your interest rate. While debt consolidation has many pros, there can be hidden cons, such as upfront fees, prepayment penalties, and unmanageable monthly payments. Debt consolidation is not the answer to all financial difficulties, and bankruptcy provides many benefits and legal protections not available to those seeking to consolidate their debts.

For a free case review from the Philadelphia bankruptcy attorneys at Young, Marr, Mallis & Associates call (215) 701-6519 or (609) 755-3115 today.

How Does Debt Consolidation Typically Work?

Debt consolidation is a financial strategy our lawyers can use to reduce the interest rate and the total monthly payment on a debt, like credit card bills. It is typically accomplished by grouping all your outstanding debt under one loan, thus consolidating your payments into one monthly payment. There are several ways to accomplish this, and the method our lawyers advise will often depend on your total debt and credit score.

Consolidation Loans from Banks

For example, you could apply for a consolidation loan from a bank, credit union, or other financial institution. Typically, a person will apply for a personal loan to pay their outstanding credit card debt. The advantage of this method is obtaining a significantly lower interest rate, which will also lower the monthly payment. However, fees are usually involved, and if you are a homeowner, the bank might require securing the loan with your property. Furthermore, you will need a relatively high credit score to be approved for a consolidation loan. If your credit score is average or below average, you might not receive a much better interest rate than your credit cards. Our lawyers can help you weigh this when reviewing debt consolidation loan terms before you sign the contract.

Help from Debt Consolidation Companies

Another alternative is using a debt consolidation company. These companies will work directly with your creditors to negotiate a lower interest rate or total balance. While your creditor does not have to agree, these companies have the advantage of having multiple debtors under contract. One disadvantage is that many consolidation companies charge additional service fees. It is not uncommon for these fees to surpass any negotiated savings. You should review any agreement with our seasoned Pennsylvania bankruptcy attorneys to determine if bankruptcy is more cost-effective.

Self-Negotiating with Lenders

You could work with each of your creditors individually, attempting to lower the interest rate or your total balance. However, if you have been making minimum payments every month, a creditor is unlikely to entertain lowering your payment. Our lawyers can gauge creditors’ willingness to negotiate early on in your case so that we do not waste valuable time discussing better terms or lesser payments with lenders ready to pursue wage garnishment or creditor lawsuits.

How Does Bankruptcy Work Compared to Debt Consolidation?

Debtors overwhelmed with credit card debt, medical bills, or personal loans could benefit from filing for bankruptcy. Depending on their circumstances, consumers file Chapter 7 or Chapter 13. Bankruptcy and debt consolidation loans differ in many ways, starting with the fact that bankruptcy can come with a debt discharge. If you file Chapter 7 or 13 bankruptcy, your case will go through the courts. This provides a level of judicial oversight unavailable during debt consolidation negotiations, helping to expose possible predatory lending and prevent creditors from wrongly harassing debtors or taking their assets.

Chapter 7 Bankruptcy vs. Debt Consolidation

In Chapter 7, a debtor will discharge their unsecured debt in a matter of a few months. While there is the potential turning over personal property to satisfy your debts, in nearly every situation, you will be able to protect your assets through the available bankruptcy exemptions, which our Philadelphia Chapter 7 bankruptcy lawyers can help you claim.

Debt consolidation companies often charge additional fees on top of the debt you must pay back. If you qualify for Chapter 7, you could eliminate all of the debt without paying your creditors a penny. Additionally, the attorneys’ fees are often significantly lower than what you would be required to pay over the length of your payment plan with a consolidation agency.

Another advantage to filing for bankruptcy is that there are no tax implications when your debt is discharged. If you or a debt consolidation agency negotiate a reduction in the total amount owed, you could owe federal income tax on the forgiven debt. When your debt is discharged, you are not required to include it as income for tax purposes.

Chapter 13 Bankruptcy vs. Debt Consolidation

A Chapter 13 bankruptcy differs in that you must pay back some or all of your debt over three to five years. While Chapter 13 does not appear as advantageous as Chapter 7, it is designed for individuals who can afford to pay their debts, but just need more time to do so without creditors harassing them or threatening lawsuits. The benefit is that the amount paid is based on a calculation and not negotiated. Therefore, if the numbers are in your favor, you could pay substantially less than you owe. Our Philadelphia Chapter 13 bankruptcy attorneys will carefully review your income to determine your monthly payment, which we will submit to the court for approval during your case.

Even if you file a Chapter 13 bankruptcy case, you could be required to pay less than the full amount you owe after our lawyers negotiate repayment plans and address dischargeable debts. Before agreeing to work with a debt consolidation agency, reviewing your situation with our attorneys is a good idea so you know all your options.

What Are the Pros and Cons of Debt Consolidation?

Debt consolidation loans can have pros and cons, depending on your financial situation. For example, predatory lenders might charge costly upfront fees or hide them within the contract, hurting debtors down the line. And, while debt consolidation may give you fewer bills to manage, the offer on the table might be unfair, so having our lawyers review all contracts before you agree to loan terms is crucial. Otherwise, you might be unable to pay your new lender, putting you right back into a challenging financial situation.

Fewer Bills to Manage

Rolling all eligible debts into one consolidated loan leaves you with fewer bills to manage moving forward. Instead of having to stay on top of payments to multiple creditors, you will only need to pay your new lender to avoid falling further into debt. Despite having fewer bills to manage, you are still liable for repaying your new lender the full amount owed, so the new monthly payment must be feasible for you to pay. Our lawyers can ensure this before you sign a debt consolidation loan and accept your new lender by reviewing your income, expenses, dependents, and other financial information. Missing any debt consolidation loan payments would put you back in the same situation as you started, at risk of wage garnishment, creditor lawsuits, or other debt collection efforts.

Upfront and Hidden Fees

Debt consolidation loans from banks or other companies typically come with upfront fees that could be difficult to pay, depending on the applicant’s financial ability. If you are already struggling financially, origination and balance transfer fees could be stressful.

Furthermore, it’s important to carefully read the new consolidation loan contract in case it contains prepayment penalties. This could lead to additional charges for debtors already struggling and is a common predatory lending tactic that our lawyers can look out for.

Rebuilding Your Credit Score

When debt consolidation loans work properly, they can steadily help debtors rebuild their credit. While getting the loan may require a hard inquiry and a temporary hit to your credit, making your new monthly payments toward the debt consolidation loan can help you improve it over time. This is one of the pros of debt consolidation since debtors are typically concerned with their credit health, which could prevent them from taking certain steps, like purchasing a home or a car.

To ensure a debt consolidation loan actually benefits your credit score and doesn’t hurt it, our attorneys will look out for any hidden prepayment penalties or other words that could hinder you down the line. If debt consolidation isn’t the appropriate approach to tackling your debt, seeking a loan could further hurt your credit score. Because of this, our lawyers will carefully assess your case and financial situation before advising you to pursue debt consolidation over bankruptcy.

Unfair Offers

When you apply for a debt consolidation loan from a bank or other party, the lender could offer you unfair terms somewhat hidden in the contract that, if you accept, could negatively affect your ability to rebuild credit and address your debt. Unfair debt consolidation loans could have too high interest rates and other terms that make monthly payments harder over time despite consolidating debts into one loan. This is one of the many reasons why our lawyers review debt consolidation loans and oversee negotiations with lenders is crucial. Otherwise, you could be on the hook for another loan you can’t pay back.

Contact Our Pennsylvania Bankruptcy Attorneys Before Consolidating Debt

Call our Bucks County bankruptcy attorneys at (215) 701-6519 in Pennsylvania or (609) 755-3115 in New Jersey for a free case review from Young, Marr, Mallis & Associates.