Understanding Private Debt Consolidation
The typical private debt consolidation plan is to try to negotiate your debt through payments or an offer of a lump sum that is less than your overall balance. Typically, you will cease making payments directly to the creditors you have enrolled in the plan and start making a payment to the company in lieu of those payments. As the company builds up money, they will attempt to negotiate directly with the creditors. While you continue to make these payments, typically no money is flowing to the creditors.
Why is Debt Consolidation Problematic?
Debt consolidation companies promise to take your debts, combine them into a new account, and negotiate. It sounds like an easy way to reduce your debt and the amount of interest you pay overall. But the truth is that debt consolidation is just a commercial service sold to consumers. Unlike bankruptcy, it is not a legal process and right as guaranteed under the United States Constitution.
When a debt consolidation provider talks to your creditors, there is no guarantee that the creditors will be interested. They are not obligated at all to work with the debt consolidation company. Nothing stops the creditors from suing you and garnishing your wages if they do not accept the negotiation or if it takes too long to come up with the funds necessary to settle the account.
In short, debt consolidation is problematic because it is not a debt relief method that is officially backed and protected by federal law. If you take this route, then you will be putting your faith, finances, and future in the hands of a process that might not make a positive difference.
What are the Risks of Debt Consolidation?
The main risks of debt consolidation if it does not help your situation are:
- Credit score damage: In the process of consolidating your debts, these companies will tell you to stop paying your debts directly. These missed direct payments will reflect on your score. Also, if they are successful, they will be settling the debts for less than the amount owed, which will be negatively reflected. As a result, your credit score could be worsened before your debts are even consolidated.
- Unadjusted interest rates or amounts of debt: There is no guarantee that a lower overall interest rate or amount of debt will be possible through debt consolidation. Your creditor's participation in these types of programs is 100% voluntary.
- Losing collateral property: Debt consolidation won’t negotiate agreements to catch up on missed mortgage or car loan payments. You could still lose your home to foreclosure or car to repossession.
- Significant fees: Debt consolidation companies do not work for free and most take their fees upfront before any money goes to your creditors. You will owe them fees for their services. If the consolidation is not successful or makes things worse, then you will have to pay them, which is probably not a cost that your finances can take.
- Increased debt: When all of the other potential consequences of debt consolidation are factored together, it is possible that you can end up with more debt than when you started.
- Tax consequences: The forgiveness of debt other than through bankruptcy or while insolvent is considered taxable income. Even if the debt consolidation company is successful, you could still face a significant IRS bill in the end. Next tax season after a debt consolidation, you will have to show proof that the amounts that were forgiven are not counted as income, too.
- Lawsuits: Typically, the first step of debt consolidation is to stop paying your bills and instead start paying money to the debt consolidation company. When this happens, creditors will often get impatient and initiate a lawsuit to collect. If this happens before there are sufficient funds to settle the debt, you could face garnishments and other aggressive collection attempts.
- You may still wind up in bankruptcy: If the debt consolidation fails or if uncovered debts become too pressing, you will most likely wind up in bankruptcy after several months or years.
- Most debts are ineligible: Debt settlement companies focus on credit cards and unsecured signature loans. They do not usually work with student loans, secured loans (like vehicles and houses), payday loans, and medical bills.
What Can You Do Instead of Debt Consolidation?
Rather than rushing into debt consolidation, you should speak with Watton Law Group about Chapter 13 or 7 debt adjustment through the courts. Bankruptcy can be an incredibly helpful and positive process, especially when it is managed by a professional bankruptcy attorney. When done right and in certain circumstances, bankruptcy can discharge all or most of your debt, allow you to keep all or most of your important assets, and make a minimal and reversible impact on your credit score.
Get Your Questions Answered Today
If you are struggling with debt, do not head straight to a debt consolidator’s office. Instead, come to Watton Law Group and let our attorneys know about your situation. We will give you an honest and transparent assessment of what we think the best way forward will be. For many of our clients, filing for a Chapter 13 debt adjustment or Chapter 7 instead of using debt consolidation has been far more effective and far less frustrating, so this might be the case for you, too.
Seek reliable legal counsel by using an online contact form now.
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