As of 2020, the balance of consumer debt in the US was around $800 billion. For individuals, student loans become a nightmare when they fall short on their payments. So, they look for ways to get out of it.
However, in order to get out one loan, they might get stuck into another one. And that too, with a much hefty interest rate on the new one. Many individuals turn towards debt consolidation as the solution to their problem.
But before you jump into it, it is important to have an understanding of its framework. Let’s begin by understanding what debt consolidation is.
Debt Consolidation Definition
Debt consolidation is the process that merges all your small loans into a big one. It allows you to pay all your smaller loans by taking hefty ones. Since you now have only one debt to pay, you will be safe the burden will be significantly lower.
Moreover, consolidation saves you from the hectic of paying different creditors as you now have to pay only one creditor. Also, it can have a longer tenure period and a lower interest rate in comparison with small loans.
However, this is only applicable on non-collateral loans such as student loans, credit cards, or personal loans.
Merits and Demerits of Debt Consolidation
Now that you have a brief idea of what debt consolidation is, let’s see its merits and demerits:
One of the best things about debt consolation is that you don’t have to worry about multiple payments. As a result, you don’t have to worry about missing a deadline or paying a hefty charge on it. Since all of your debt is in one place, it is easier to keep a track of it.
In addition to that, you can enjoy a lower interest rate on it. Since there is a huge sum of money you are going to borrow, you would have the leverage of negotiating for a lower interest rate. You won’t have to worry about calculating different rates on multiple loans.
Moreover, debt consolidation saves you from spiraling into more debt. If you have a credit card with heavy interest, you might be taking on more loans to pay interest only. Therefore, you will be stuck on the debt track. However, with debt consolidation, you will have a fixed rate of interest that you need to pay.
With a lower interest rate, you can save up money that you were using to pay interest. You can use that money for other purposes like making a balloon payment to get out of debt forever.
Although debt consolidation might sound like a great way to reduce your debt, it isn’t as simple. The whole process requires a lot of planning before you go for debt consolidation. If you jump right into it without proper planning, chances are that you might drown in debt again.
Also, with extra money in your hand, you might spend on items that you don’t need. Therefore, it will bring no benefit for you as you didn’t utilize the freed up money for other purposes.
Besides this, another thing that can become a hurdle for debt consolidation is your credit score. If you have a bad credit score, chances are you won’t be getting debt consolidation. Even if you do, you will be paying the same interest rate or possibly higher.
Regulations and Framework for Debt Consolidation
The FTC has a framework set up for consumers to help them cope with their debt. The federal agency requires companies to follow these rules to save customers from exploitation. Below are some of the regulations and the framework that debt consolidation companies have to oblige to:
- Consumer’s Money Needs to Held in an FDIC Bank
- Accurate Numbers to be given To Consumers
- Consumers Need To Know About All the Fees Beforehand
- Companies Need To Set a Time Frame Debt Consolidation
As per the guideline of the FTC, the company needs to place the consumer’s funds in an FDIC (Federal Deposit Insurance Corporation) bank. This will give the consumer full ownership over their money which they can control.
Previously, companies often manipulated consumers into thinking that they are depositing money which they can later withdraw to settle their debts. The companies use to take that money to uninsured financial institutions. Therefore, the FTC has introduced some rules in their framework that companies have to follow.
Another key regulation that companies have to follow is to state the accurate figure that the consumers will save. As per the rules in the FTC Debt consolidation framework, companies will have to advertise the right information that will show how much consumers will save by enrolling in their program. Also, these numbers have to be backed by reports of settlements with previous clients.
The debt consolidation company must disclose all the charges and explain clearly how debt consolidation works. They should inform customers about the fees prior to signing the deal. In addition, they need to discuss their refund policy with the consumers so to avoid any confusions.
Apart from this, the FTC also prohibits companies from collecting the whole payment from the consumers upfront.
The companies that provide debt consolidation services need to give their consumers a realistic time frame. This time frame will allow customers to know when the program will end. It should be through proper calculations and as per the reports of the previous encounters with the creditors.
As a customer, you have a right to know about any fees you may be charged prior to signing the debt consolidation deal.
Documentation Necessary for Debt Consolidation
Once you are sure about going for a debt consolidation program, you need to gather all the documentation. A lot of times, the necessary documentation depends on your credit history. However, there are a few things that are a prerequisite in any case. Here is a list of all the necessary items:
- Employment Letter
- Pay slips
- Statements of credit card and loans for last two months
- Letter from creditors
With proper planning, you can avail debt consolidation to decrease the burden of interest rates and become debt-free much quickly. However, before you sign up for anything, make sure that you go through the terms and conditions of the contract. Also, it would be best to stay up-to-date with the TFC’s guidelines debt consolidation framework.