Gathering Interest: The Case for Debt Consolidation

If you're disciplined, consolidating your credit card bills into a single loan can be a wise financial move.

Debt consolidation can lower your overall interest costs, reduce your monthly payoff, eliminate late fees and over-the-limit charges, and allow for one, convenient monthly payment. On paper, it's a no-brainer.

But that doesn't account for your behavior.

Ask anyone who counsels debtors, and they'll tell you that you had better be sure of yourself if you're planning on using a loan to help you get out of a spending rut.

"Unfortunately, about half of Americans use money and credit as a way to distract themselves from their lives, and they spend unconsciously," says Steve Rhode, president and co-founder of Myvesta.org, formerly Debt Counselors of America, in Rockville, Md. "What I see a lot of times are people who get a loan and then six months later the debt is starting to creep up again."

It's akin to performing radical surgery on someone whose untreated bad habits just lead back to the same maladies that the operation was meant to correct. But, for those consumers who are resolved to straighten out credit snarls, consolidations can be a boon.

"If you have high interest rate debt outstanding and you're striving to pay that back as quickly as possible, then it pays to look into consolidating, whether that just means switching to lower rate credit cards or whether you want to utilize the equity that you have in some other asset," says Greg McBride, a financial analyst with Bankrate.com, in North Palm Beach, Fla.

According to the Federal Reserve Board, Americans carried more than $701 billion in credit card debt by the end of 2001 at an average interest rate of nearly 15%. Industry tracker CardWeb.com Inc., based in Frederick, Md., reports that the average household has six cards carrying a monthly balance of about $8,400 with rates as high as 41%.

Of course, some consumers greatly exceed the average. Rhode has a client with 78 credit cards owing $1 million. Families seeking help from the Consumer Credit Counseling Service in Milwaukee typically have $28,000 in credit card debt, says Kathryn Crumpton, counseling supervisor for the nonprofit United Way agency.

Some debtors could benefit from consolidating their costly balances into one lower-rate plan. For instance, taking four $3,000 card balances at 19%, 18%, 17%, and 16% and putting them into one loan at 10% would save about $43 a month in interest payments. Set those savings aside--don't spend it, and you'd have $1,500 in three years.

"If you want to cut your dependency on credit cards, you have to have savings to go to instead of pulling out the plastic," Crumpton says.

The most common arrangements for consolidation include:

A low-rate card. You could transfer accumulated credit card balances to one card with a rate that beats what you're paying overall now. Drawbacks: Attractive "teaser" deals often morph into less favorable terms soon after activation. Read the fine print and beware of fees not only from the new card but also from terminating the old accounts.

A home equity loan. For homeowners, this may be the best way to reduce interest costs. Rates on a second mortgage are lower because lenders can seize your house if you default. Also, mortgage interest can be tax deductible, making the effective rate even less. Drawbacks: Lenders can seize your house if you default!

A counseling agency. Instead of getting a new loan, you could pay a third party to arrange lower rates and longer paybacks with your creditors and then manage the repayments for you. The best services try to teach you how to live within your means. Drawbacks: "It's always best if you can pay off your debt on your own, as far as your credit report," Crumpton says. Also, burgeoning consumer debt has begotten some shady operators in this field, so know whom you're dealing with.

The first step toward clearing your credit card clutter is to assess how bad off you are. Get a copy of your credit report and contemplate how you got so deep into debt. If you're surprised by how much you owe, if you've reached the limit on your cards, if you're struggling to pay the monthly minimum, if a job loss or emergency bill would wipe you out, you should look into consolidating.

Unless you already have a low-rate card from your credit union, call your card issuers and ask how much they'd be willing to lower your current interest rates. A recent study by the Massachusetts Public Interest Research Group found that every other credit card customer who requested a lower rate got a rate reduction of about 33%. Take advantage of your credit union membership to seek advice and take stock of the services available to you.

But don't attempt to start tackling the problem until you come to grips with its cause.

"The problem is that money problems are not about the money. They're about underlying causes which cause you to spend unconsciously," Rhode says. "You have to ask yourself, are you organized and diligent? Because if you're not, you're going to get right back into the same spot to begin with."

That's when you may need professional help.

A recent three-year study from the Georgetown University Credit Research Center, in Washington, D.C., and the National Foundation for Credit Counseling (NFCC), in Silver Spring, Md., concluded that consumers who received individual counseling, budget reviews, and written action plans tend to gain better control of their finances.

"You can come in and sit down with a counselor and have a financial assessment at no charge," says Crumpton, whose agency is one of 155 members of the NFCC. "If we feel you can handle this on your own, we'll give you the tips to do that and let you go ahead. We have classes to better help you manage your finances. Education is really, really important in helping people learn to manage their money."

Published July 15, 2002