Debt Consolidation

How to Avoid Debt Consolidation Scams

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Debt consolidation is when you combine multiple existing debts with a new loan, line of credit or another financial product. You can consolidate debt using a variety of methods, such as a personal loan or credit card.

Unfortunately, you might encounter debt consolidation scams that put your personal information at risk, damage your credit or bury you in hidden fees.

How does debt consolidation work?

Debt consolidation can work in various ways. Here’s a simple breakdown of common debt consolidation methods:

Common ways to consolidate debt
  How it works Pros Cons
Debt consolidation loan A personal loan you use to pay off existing debt but with better terms and a fixed rate.
  • Can reduce monthly payments and/or total debt costs.
  • Roll multiple debt payments into one.
  • Can be hard to qualify for.
  • Bad-credit borrowers will see high rates, if they qualify.
Balance transfer credit card A balance transfer card allows you to move debt from one or more credit cards onto a new one.
  • Can offer a low intro APR for new cardholders.
  • Allows you to ditch high-rate cards.
  • Intro APRs can be short-lived and only available to strong credit borrowers.
  • Variable rates on cards are unpredictable.
Debt management plan A financial professional or nonprofit credit counseling agency creates a repayment plan for your debts and negotiates with creditors on your behalf.
  • Nonprofit debt consolidation is a generally trusted option.
  • Viable option for those with bad credit.
  • Can take years to reach debt freedom.
  • Doesn’t work for most secured debts.
  • You may be charged fees.
Debt settlement You make payments to a for-profit company instead of your debts. That company then attempts to negotiate with creditors for a lower payoff amount than what you owe.
  • You may be able to reduce your payoff amount.
  • The effort of negotiating with lenders is outsourced.
  • Hefty fees with no guarantee the service will work.
  • Your credit could take a hit.
  • Scams are common.

Debt consolidation loan

One common method to consolidate debt is by taking out a debt consolidation loan (a type of personal loan). Using the funds from your new loan, you pay off your existing debt. Afterward, you’ll make regular payments on your loan.

By taking out a new loan, you have the opportunity to secure a lower interest rate than what you’re paying. You could also choose a shorter repayment period to get out of debt sooner, or a longer one to reduce your monthly payments. In the former case, you’d have higher monthly payments but pay less interest overall; the opposite is true in the latter case.

Debt consolidation loans are typically unsecured, meaning they don’t require collateral. However, some lenders will offer debt consolidation loans that are secured, by items like your car or savings in a bank account. It’s also important to note that you can use other kinds of loans, such as a home equity loan, to consolidate your debt. Debt consolidation loans are just a common tool to combine your debt.

Balance transfer credit card

You could also consolidate debt with a balance transfer credit card. These credit cards can come with low introductory rates for a set period of time. This can allow you to pay off any debt you transfer over at a reduced rate. Keep in mind, you’ll need to pay off your balance before the introductory period expires, or else you’ll accrue interest on your unpaid balance.

In many cases, expect to pay a balance transfer fee, as well — this is typically equal to 3% to 5% of the transferred amount.

Debt management plan

A debt management plan works differently from a debt consolidation loan and balance transfer credit card. When you sign up for one of these plans, you’ll work with a credit counselor from a nonprofit credit counseling agency. Your assigned counselor will create a three-to-five year payment plan to help you get out of debt.

You’ll make payments directly to the agency instead of your creditors. Your credit counselor will handle distributing your payments while also negotiating on your behalf to have fees reduced or waived.

Debt settlement

As a rule, be wary of debt settlement programs. These programs can charge high fees and damage credit, all without any guarantee of getting you out of debt.

Here’s how they work: You’ll sign up for a program and may be asked to stop making payments on your debt (which can severely damage your credit and lead to collection calls). Instead, you’ll make monthly payments into an account set up by the debt settlement company. Once you’ve saved up a large amount of cash, the debt settlement company will use that cash to negotiate with your creditors for a lower payoff amount than what you owe. If successful, your debt will be wiped out for less than what you owe.

The problem is these services don’t always work, and can leave you with damaged credit and high fees due to missed payments. The Federal Trade Commission (FTC) warns that scams are common in this arena, so in general, it’s best to cut out the middleman and fees and try negotiating debt settlement on your own.

7 warning signs of a debt consolidation scam

When seeking out debt consolidation, you may encounter “debt consolidation companies” that are actually businesses offering debt settlement services. You might also run into shady companies that don’t offer any legitimate services, but instead seek to prey on people struggling with debt.

Here are warning signs to beware as you explore debt consolidation:

  1. You’re asked to make a payment when nothing has been done yet
  2. The company is pushy
  3. You’re told to cease contact with your creditors
  4. You’re told to stop paying your bills
  5. The company is hesitant to share information with you
  6. You get an unsolicited offer from the company
  7. The company promises to lower your total debt amount

1. You’re asked to make a payment when nothing has been done yet

If you’re getting legitimate financial counseling, it’s fine to pay for that service. But for-profit debt settlement companies will sometimes ask for a high fee upfront. This should be a warning sign as you haven’t received any actual assistance in reducing or settling debt.

The FTC actually prohibits for-profit debt services that sell help over the phone from charging a fee before they’ve delivered on any promises.

2. The company is pushy

Beware any company that uses aggressive tactics to try to get you to sign up for their services or to hand over personal information. This can include spamming you with phone calls to sign up or threatening you if you don’t sign up.

3. You’re told to cease contact with your creditors

In general, terminating all contact with creditors when you owe them is an ill-advised move. If you’re struggling to make payments or are buried in fees, you should always feel free to contact your creditors to explore any potential options.

4. You’re told to stop paying your bills

Debt settlement companies often tell consumers to stop paying their bills while enrolled in the program. This can be consequential as it can lead to a mountain of late fees and interest, or lead your debt into collections.

5. The company is hesitant to share information with you

If you feel as though the company you’re working with is hesitant to provide information, be skeptical. Terms of service should be transparent before you make any sort of commitment. If the company appears to be shying away from delivering information about what it does, or won’t disclose what fees they charge, move on.

6. You get an unsolicited offer from the company

Be wary of any services that contact you via an unsolicited call or junk mail. More legitimate financial organizations, including nonprofits, aren’t going to be knocking down your door. As always, research any companies you plan to work with. Read consumer reviews, as well, to see how others have felt about working with the company.

7. The company promises to lower your total debt amount

If a company promises that it’ll lower your debt significantly, you should probably turn your back on them. Guarantees don’t exist in debt consolidation or settlement, because there’s no assurance about what they’ll be able to negotiate with creditors.

Quick tips to avoid a debt consolidation scam

  • Do your research: The more you know about a company, the far less likely you’ll be scammed. Looking up their reputation with the Better Business Bureau and checking for any complaints filed with your state’s attorney general is a great start.
  • Seek multiple offers: Comparison shopping can only help increase your odds in finding a legitimate partner to help you with your debt. In addition to looking for loans online, talk to your local bank or a credit union, especially if you’ve worked with them before.
  • Compare these offers: Write out the major details for all of them, such as interest rates, origination fees, repayment terms and minimum credit score required.
  • Get everything in writing: It’s much harder to have recourse should something go awry if you don’t have details in writing. The terms and agreement ought to be as clear as possible.
 

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