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When consumers want to make a big purchase such as a car or a vacation, many need to take out a loan or use a credit card to do it. The result is that millions of Americans are carrying debt, lots of it.
In fact, according to the Federal Reserve Bank of New York, at the end 2016, Americans were carrying a staggering $3.37 trillion in non-housing debt. Credit card debt makes up $710 million of that debt with over 7% of those accounts being 90 days or more delinquent. Debt is now over its all-time high level reached during the Great Recession in 2008. While a larger percentage of that debt is not delinquent compared to 2008, it still represents a potential problem for the financial health of our country and its citizens.
How do people get into credit card debt?
With so many Americans carrying a large amount of debt, it begs the question of how folks accumulate that debt. Often times, the reasons for debt accumulation are not due to carelessness or overspending. Many times, it is due to circumstances beyond a consumer's control. However, some Americans are poor money managers who know nothing about budgeting or saving, and they accumulate debt by overspending and being unprepared for life's unexpected emergencies.
Let's look at some of the reasons consumers may find themselves stacking up debt through consumer loans and credit cards.
When someone loses a job and source of income, the results can be financially devastating. If unable to find work immediately to replace the level of lost income, the individual could turn to credit cards very quickly. Unless a substantial amount of money is in the bank, debt could start accumulating in no time at all. If unemployment goes on for some time, a substantial amount of debt often arises.
In addition to the financial aspects of losing one's job, unemployment brings many emotional aspects with it. A person's job helps that person know his or her place in the world, and the loss of it can bring anxiety, stress, and marital problems. When a person feels stress, he or she is less likely to pay attention and be diligent with budgeting and paying bills. This could lead to even more financial problems.
When someone loses a job and has little to no income coming in, it is sometimes necessary to take a lesser paying job to keep some money coming in. Many hope this will be just a temporary situation and will continue to look for a job that pays a salary closer to expectations. With the job market depressed for the last few years, this has been a difficult proposition for many consumers.
Many consumers find it difficult to cut spending and adjust their budgets to make up for the loss of income. With not enough income coming in to cover the bills, many will have no choice other than to turn to credit cards to make ends meet. If underemployed for an extended time, they could find themselves accumulating a substantial amount of credit card debt.
When someone becomes ill unexpectedly, it can cause serious ripple effects. Aside from the physical and emotional trauma an injury or illness can bring, it can also have a serious impact on a family's financial health and well-being. Aside from the loss of income if a person is unable to continue to work, medical bills can be quite expensive and add up quickly. Prescriptions, co-pays, and deductibles can add up to a huge amount in a very short time, even with a good medical insurance policy.
Faced with reduced income and mounting medical bills, many may need to turn to credit cards to pay for everyday expenses or pay upfront fees and co-pays. Anyone faced with a big bill from a hospital or other provider should ask about discounts and payment plans. Many providers offer sliding fee scales based on income. In addition, many will give a substantial discount for paying the entire amount in one payment.
Few things will turn a house and a family upside down like a divorce will. Splitting up households usually means doubling overhead expenses such as rent and utilities, generally without adding any additional income to the picture. As overhead expenses go up, so do the legal fees.
Many times, couples will need to use credit cards to cover the increased overhead expenses. Since divorces can take a long time to resolve, bills and credit card debt can pile up. If possible, couples should try to work together to dissolve the marriage in the quickest and most financially reasonable way possible.
Many consumers overspend as a matter of habit. Living paycheck to paycheck has become the norm in America for many. Consumers fail to realize that spending every dime they make and then some is a losing proposition. Credit cards have become a vehicle for overspending, and with banks and other lending institutions loosening their lending practices, this will only become a bigger problem.
Many people overspend simply because they don't know any better. Money management is not a skill taught to students in America. Without the basics of budgeting and financial management, many consumers are on their own to figure out their financial lives.
One of the biggest reasons consumers fall into credit card debt is that they are either unable or unwilling to save money. With no savings, they are unprepared for any large expenditure that is outside of their ordinary expenses. With no money in the bank to fall back on, even the most basic unexpected expense will cause them to turn to credit cards. Using credit cards to cover for a lack of cash is a bad habit.
There are only two ways to stop the accumulation of debt: lower expenses and spending or increase income. Doing at least one of the two will allow consumers to create savings that can help pay off debt and handle emergencies. There is no way consumers can borrow their way out of debt.
Sometimes, debt accumulates because there is simply not enough income to meet expenses. This happens commonly to senior citizens who do not have enough retirement income. Many seniors find it difficult to survive without relying on credit cards to cover even the most basic of expenses. Medical bills, supplemental health care insurance, and prescriptions are commonly very costly for senior citizens in America.
Those that find themselves underemployed through a reduction in work hours or pay or by having to take a lower paying job can also find themselves having to rely on credit cards. Not having enough cash to meet your expenses is often a recipe for accumulating a significant amount of credit card debt.
Is taking a personal loan the right way to address debt?
There are several ways to address your debt if it has gotten out of control. Many consumers consider getting a personal loan. There are some advantages and disadvantages to taking out a personal loan. Let's review a few of them.
Advantage: Low risk to the consumer
Personal loans do not require that the borrower put up any collateral for the loan. This means that the only thing at risk for the consumer is his or her credit reputation. This also makes the loan process easier.
Advantage: No risk of losing your home
Because banks, finance companies, and other lending institutions do not require any collateral for a personal loan, you do not have to mortgage your home in order to raise the funds. The lower risk provides peace of mind for the consumer.
Advantage: More streamlined process
Personal loans do not go through the extensive underwriting process that mortgages do, so the loan application, processing, and closing process will be much quicker. This also makes it easier on the borrower since the bank will not be requiring as many documents and verifications.
Disadvantage: Usually have a lending cap
Because personal loans have no collateral backing, there is a higher risk of default for the lender. Due to the increased risk, the lender will usually have a limit to how much it is willing to lend the borrower. This could make a personal loan not ideal for consumers who have a high amount of credit card debt.
Disadvantage: Need very good credit
Because personal loans represent a high risk of default for the lender, many banks will require a very high credit score. Otherwise, borrowers with a low or marginal credit score will be required to pay a much higher interest rate. The rate may not be much less than what they are already paying on their credit cards. It's important that consumers shop around for the best rate and make sure that the rate offered makes sense for their individual situation.
Disadvantage: Lack of flexibility
When a consumer secures a personal loan, it will have a defined payback plan. They will have to pay a predetermined amount every month to pay off the loan. If an income situation changes, the obligation to pay remains. There is no minimum payment option like there is with a credit card. Additionally, if the consumer is able to pay the loan off early, he or she may be required to pay a prepayment penalty.
What are the other options?
If a personal loan does not fit a consumer's needs, several other loan and debt management options exist to consider.
Home refinance with cash out
If a consumer owns his or her home and has enough equity, it may be possible to refinance the home and take some cash out to pay off credit card debt. The advantage to this is the consumer will likely be able to obtain a much lower interest rate than what he or she is currently paying on credit cards. The disadvantage is that the consumer will be adding to his or her mortgage balance and will be paying off the debt for a very long time.
HELOC (home equity line of credit)
A home equity line of credit allows consumers to tap the equity in their home and use the proceeds in any manner they see fit. Borrowers usually receive approval for a certain amount and can then withdraw money from the credit line on an as-needed basis. The advantage of a home equity line of credit is that consumers can pay back against the line in a manner that fits their needs as long as they pay the interest due on the money borrowed. The disadvantage is that they have increased their mortgage balance and moved their credit card debt from an unsecured position to one secured by their home.
DIY debt management
Some consumers take a do-it-yourself approach to paying off their debt. Assuming they have enough income, they can set up a repayment plan to pay off their credit card debt within three years. By looking at the front of any credit card statement, consumers can determine the monthly payment needed to pay off the credit card balance off in 36 months.
If consumers can find no solution to their credit card debt other than bankruptcy, they should consider utilizing a debt relief company. Companies such as National Debt Relief help consumers by working with their creditors to settle the amounts they owe. While this process will have a detrimental effect on a consumer's credit score, it will be less damaging than declaring bankruptcy. A bankruptcy will stay on a consumer's credit for many years and have a significant impact on his or her ability to obtain any kind of credit.
Finding the right solution to your credit card debt is not always an easy process, but with due diligence, consumers can find their way to the ideal solution.