Is Credit/Debt Consolidation the Answer?

By Nancy Zambell, Contributing Editor


Our national savings rate has been declining for more than 20 years. And according to Goldman Sachs' research, the 2006 accumulated net savings rate for household, business and government savings as a share of Gross National Income was a paltry 1.6%. That's better than when it dipped below zero the year before, but it is still the lowest of G-20 countries, who often post double-digit rates.

Instead, our country has increasingly become a nation of debtors. According to Michael Hodges, editor of the Grandfather Economic Report, total debt in the United States has risen to more than $53 trillion at the end of last year from $693 billion in 1957! That equals more than $175,000 for each American citizen.

Household debt has soared to almost $14 trillion, and over $2.5 trillion of that is just for credit card debt. According to creditcards.com, some 10% of us have more than 10 credit cards, 8.3% of us owe more than $9,000 in credit card debt, and the average outstanding credit card debt amounts to more than $2,200 per household.

While those numbers don't seem as bad as some of the headlines have recently touted, the problem is two-fold: credit card debt is growing and financial institutions are rapidly increasing the corresponding interest rates and fees. Consequently, more families will be scraping the bottom of the barrel just to stay afloat.

While the Fed is lowering other Rates, Credit Card Rates Continue to Soar

The Federal Reserve rate cuts are helping banks who borrow and lend to each other, but consumers aren't reaping any advantages yet from the reductions. Instead, credit card debt rates are on the move up.

Interest.co.nz reports that more than 71% of folks paid interest on their credit cards in February, up 3% from January, and they paid an average of 19.9% interest.

And as the delinquency rates on consumer debt continue to accelerate, credit card rates and other fees are also climbing very sharply:

• Washington Mutual is raising rates on some customers by as much as 100%.

• Bank of America tripled rates for a portion of its customers in March

• Capital One raised its cash-advance fee to 23% from 19%. They also reduced their grace period to 25 days from 30.

• Bank of America changed its balance transfer policy, so that it now charges 3% for each transaction, instead of capping fees at $75 to $100.

Additionally, penalty fees are also growing. Last year, banks brought in a record $18.1 billion in penalty fees on credit cards alone, up 69% from 2003, according to R.K. Hammer, a consulting firm. The company expects those fees to leap an additional 5.5% this year. Already, Discover has increased their penalty fees to 31%.

And consumers need to be aware that these penalties are not just being implemented for paying late by a few days, or exceeding credit limits. They can also be levied if you pay your bill late by just one minute or make a late payment to some other creditor. Often, rates are changed based on credit scores alone, according to CardRatings.com.

Fitch Ratings is forecasting that credit card charge-offs will soar to at least 35% this year, implying that banks are not going to begin cutting rates anytime soon.

What Can You Do?

• Try to live within your means. Take a good look at your household budget, and pare down your spending on non-essential items.
   

• Pay off your highest rate balances first.
   

• Don't take cash advances on your credit cards.
   

• Don't charge non-essentials to your cards. If you can't afford a vacation without charging it, you should just stay home this year.
   

• Look for low-rate credit cards, but be careful about switching balances to new cards. Make sure the low rate is permanent, not just a teaser. And be aware that opening new credit card accounts may adversely affect your credit score.

If you are really struggling with credit card debt, there are some additional measures you can take. The first is to try to reduce your interest rates and work out a payment plan with your creditors. Most banks would rather receive some payment, instead of none.

But if that won't work, a couple of other options are available: home-equity loans or a debt consolidation loan, an instrument that will wrap your higher-interest debt into one, hopefully, less financially onerous package. But, know that both types of loan have pitfalls.

Unfortunately, statistics show that 70% of folks who use a home equity loan or other type of loan to pay off credit cards don't do themselves any favors. Within two years, they usually end up with the same (if not higher) debt load. The reason is simple: it is a quick fix, not a strategic plan to change the spending habits that got you into this very situation. There are two more issues you should also be aware of: if your debt is out-of-hand, you are probably not going to get your home equity loans at the advertised low rates, which are usually targeted to borrowers with high credit scores. And lastly -- but most importantly -- if you fail to pay your home equity loan as agreed, you could LOSE YOUR HOUSE! Consequently, a home equity loan for purposes of paying off credit card debt is not usually a good idea.

The second option is a debt consolidation loan. The convenience of only having one -- as well as a reduced -- payment is tempting. And if you feel this is your last option before more dire financial circumstances, just make sure you know the ropes.

1.  Expect a high rate of interest.

2.  Make sure your new payment is really a reduction from all your previous combined payments to creditors.

3.  Shop around for the best terms -- banks, credit unions, savings banks.

4.  Understand that this debt consolidation will most likely adversely affect your credit report.

5.  Know that you will not be able to apply for additional debt for awhile.

6.  Make sure you find a reputable debt counselor. According to Bankrate.com, you will need to "verify certifications or third-party registrations. Check with the Association of Independent Consumer Credit Counseling Agencies or the National Foundation of Credit Counseling to see if the service you're considering is a member of either group. Also ask the service for references and then confirm them."

7.  Before you sign on the dotted line, make sure you understand all of the terms and exactly how your debt will be handled. If the firm can't answer your questions to your satisfaction, go somewhere else.

However, if you can hold out a little longer, some relief may be ahead. The Federal Reserve just proposed new regulations for the credit card industry to make it harder to raise interest rates and -- at the same time -- give consumers a longer period in which to pay their bills.

Here are a few of the proposed rules:
 

• Lenders will not be able to arbitrarily raise interest rates unless a promotional rate expires or the borrower was more than a month behind in his payment.
   

• Borrowers must receive their statements at least 21 days in advance of the due date, or their payments can no longer be considered late.
   

• No more "double-cycle billing," which has allowed lenders to calculate one month of fees based on two months' worth of activity.
   

• Lenders will not be allowed to apply the whole payment first to low or zero-interest balances.
   

• Financial institutions will not be able to charge fees to open and account.