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America's debt problem is growing and, according to recent statistics, this growth trend shows no sign of slowing down. Household debt levels in America haven't been this high since the beginning of the Great Recession. The New York Federal Reserve's latest quarterly report estimates that household debt stood at $12.96 trillion as of September 30, 2017. This is a very large increase over the 2016 numbers.
This is significant because the amount of household debt Americans added in 2016 was the biggest in a decade. With interest rates low, and banks and other lenders lowering their lending standards, the environment has been ripe for Americans to borrow money. In addition, those Americans who saw their credit damaged during the financial meltdown have now recovered enough for lenders to view them as good credit risks.
With the economy now roaring back to life, consumer confidence has risen sharply. This means that Americans feel good about spending money on economy-driving purchases such as homes, cars, and big-ticket household goods. Regardless of the fact that the cost of living is still rising faster than income growth, consumers are still spending at a record pace. However, as long as income growth lags behind, consumers will continue to find it difficult to make ends meet every month. This means that many Americans will rely on credit cards to bridge the gap.
With consumer optimism so high, many Americans have once again made the leap into the housing market. While the mortgage market hasn't recovered to the level prior to the housing crash, the past couple of years have seen a sharp rise in mortgage originations. Bottom line: Americans are carrying a lot of debt in the form of mortgages, car loans, student loans, and credit card debt.
Underlying reasons why Americans are carrying so much debt
Americans are carrying a large amount of debt because they're having a difficult time making ends meet. Due to sluggish income growth, there's simply not enough money to meet the everyday expenses facing most American families. To make matters worse, most families in the U.S. have little to no savings. This means that they have very little to fall back on in the event of an emergency such as a large car repair, an unexpected medical bill, or a household expense such as a broken furnace. With no way to fund life's unexpected expenses, these Americans have no other choice than to rely on consumer credit to survive.
To compound the problem, most Americans have never been educated in money management or in the way of family budgeting. Consequently, most families have no idea where they're spending their money each month. With no budget to follow, most families spend far more money than they bring in every month. Over time, this can add up to a big problem as their credit card balances grow exponentially month after month. Eventually, they'll reach the end of their available credit and become insolvent.
When a family approaches the point where it can no longer meet obligations, it has reached a critical state. Many will ignore their state of affairs until they have no other choice except to file for bankruptcy. However, those who acknowledge the severity of the situation can take action to stop the bleeding and turn the corner toward a better financial future.
There's an old saying that you cannot borrow your way out of debt. For the most part, that's true. In essence, you can only reverse a deficit situation by cutting expenses, increasing income, or both.
Although borrowing money isn't always the best way out of debt, many consumers feel that consolidating their debt through a debt consolidation loan can give them a leg up on getting out of debt. Consolidation loans definitely have some advantages for consumers who are in trouble with their credit card debt, but there are some downsides as well. Those seeking a debt consolidation loan should consider both the disadvantages and advantages before making the decision to go forward.
The pros and cons of debt consolidation loans
Consolidation loans are attractive to consumers for a number of reasons. First, consumers are looking to lower the overall interest rate they're paying on their existing debt. In addition, the ease of making just one payment to one creditor is very attractive to most consumers, as it streamlines their lives and helps them minimize the chances of late or missed payments.
Additionally, a debt consolidation loan can be an effective tool to getting back on track and up to date on payments for those who've fallen behind and are running chronically late. Lastly, consolidated debts with a lower interest rate will most likely have a payment that's less than what a consumer has been laying out each month in credit card payments. It's easy to see how these factors can make debt consolidation attractive to consumers who are in over their head with credit card debt.
Although some of the advantages to debt consolidation are clear, some disadvantages exist that anyone considering a debt consolidation loan should be aware of. The most important of these is facing the hard truth about how one got into such a detrimental situation in the first place. If you are lacking sufficient income to keep up with your basic expenses, a debt consolidation loan may not solve your problem. You may need to take further measures to reduce your overhead expenses or add additional income by taking on a second job or starting a side business.
Being honest about spending habits or lack of discipline with money is critical as well. Understanding the root causes of a serious debt problem is essential. Even if a debt consolidation loan reduces the monthly outlay of cash, the surplus gained can quickly disappear if spending habits are out of control. Worse yet, if a lack of discipline causes credit card balances to max out again, a consumer could end up in worse shape than before.
It's important to make changes to your lifestyle before taking steps to consolidate debt. These changes help to make permanent steps toward eliminating debt for good. Formulating a budget will help a consumer to see where to cut wasteful overspending. This will help lower the overhead each month. If consumers don't make these changes, there's a good chance that they'll only continue to accumulate debt.
If a commitment to change spending habits is in place, then making a move to consolidate debt could be a good choice. Consolidation loans can come in several forms, so consumers should be sure to do the proper research to find the right fit and the best interest rate and loan terms.
Understanding different types of debt consolidation loans
When considering debt consolidation, consumers have several choices to evaluate. It's important that those considering a debt consolidation loan familiarize themselves with the different types and their characteristics before pulling the trigger on a loan. Some debt consolidation loans, aptly named secured loans, require a borrower to place something as collateral against a loan, usually in the form of real property.
Secured debt consolidation loans are usually backed by real estate, which, in most cases, involves borrowers putting up their home as collateral. Other types of loans, such as personal loans, are unsecured. This means that the bank lends the money on just a signature from the borrower. Let's take a closer look at the different types of debt consolidation loans.
Mortgage refinance with cash out
Many consumers choose this option, which taps into the equity they have in their home. A bank refinances the current mortgage, and the consumer borrows addition monies over and above the existing mortgage. The cash generated by the loan goes toward paying off existing credit card debt. If the mortgage market conditions are favorable, a borrower should be able to get a lower interest rate, which will keep the payment the same or even lower it. While this option is appealing, there are some dangers that consumers need to be aware of before making the decision to roll their debt into the mortgage on their home.
A mortgage loan will always require that the borrower pay closing costs. The borrower will have the option of paying these costs upfront or rolling these costs into the loan. Closing costs can run thousands of dollars, so whatever the buyer chooses to do, the impact will still be significant. If the borrower chooses to add the closing costs to the balance of the loan, as most do, those costs combined with the additional money borrowed to pay off debt can add a significant amount of money to a consumer's mortgage balance.
In addition, it's important to note that the borrower will pay interest on the debt and closing costs added to the mortgage balance for the term of the loan, 30 years in most cases. This could mean that consumers could actually end up paying more interest than if they'd just put their nose to the grindstone and paid off their credit cards directly. Lastly, borrowers need to be aware of the fact that, by combining their debt with their mortgage, they've now moved their unsecured debt to a position now secured by their home, their most precious asset. If at some point they find themselves unable to afford the now larger payment, they could potentially lose the home to foreclosure.
Home Equity Line of Credit (HELOC)
A HELOC is another way consumers can utilize the equity in their home to pay off credit card debt. In most cases, the bank will establish a line of credit against the home in the form of a second mortgage. The borrower is then free to draw on that line of credit up to a certain amount approved by the bank, and is then able to utilize this cash for any purpose. The borrower can also pay back the loan in any installment amount desired as long as the minimum payment, usually just the interest that has accrued, is paid each month. While this can be a useful option for many consumers who find themselves in a difficult debt situation, the same risks apply as with a mortgage refinance.
With either option, consumers need to be committed to not returning to their old ways of overspending and accumulating credit card debt once again
Utilizing a personal loan
Obtaining a personal loan is an option for those consumers who have good credit, are current on their payments, and have a relatively small amount of credit card debt. Usually, a bank, a finance company, or sometimes a credit card company extends a personal loan. These loans usually carry a limit on how much a consumer can borrow, so they may not be an appropriate option for those with a significant amount of debt.
Personal loans are unsecured loans, meaning there's no asset placed as collateral against the loan. Therefore, lenders are going to be picky about who they'll approve for a personal loan. Loan terms on personal loans are generally much shorter than mortgage loans, and while the interest rate is generally better than what a consumer is paying on credit cards, the overall payment isn't likely to decrease. Therefore, these loans are best suited for those that want to streamline the repayment process and pay their debt off quicker.
For those who can't qualify for a debt consolidation loan
In some cases, consumers wait too long to address their debt problem. When this happens, most likely, their credit will suffer or they'll have fallen too far behind to qualify for a debt consolidation loan. If this is the case, there are still some options to consider before making the decision to file for bankruptcy.
For instance, companies such as National Debt Relief can help a consumer work with creditors to reach a full and final settlement of his or her debt. The process isn't fast or easy but it's a far better alternative to filing for bankruptcy.
The most important takeaway for consumers is to avoid waiting until the situation has reached the point of insolvency. By being proactive, they can find a suitable solution to their debt problem. Those who are committed to becoming debt free and are willing to put in the hard work can find a path to a brighter, more stable financial future.