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Indiana Department of Financial Institutions

DFI > Education > Education Information > Credit Information > Miscellaneous Credit Information > Consolidation Loans or Consolidation Plans Consolidation Loans or Consolidation Plans

Consolidation Loan: A lender lends you money to payoff your bills. You payoff all your credit cards and other debt, now your payments have all been consolidated into just one monthly payment to the lender, hopefully at a lower average APR than your current bills. You should close out all the accounts you paid off with your consolidation loan, so you don't run up the balance again.

Consolidation Plan: A "bill paying service" that has the influence to work with your creditors to reduce or eliminate your interest and late fees, and agrees to send them your payment every month. You in turn pay the "bill paying service" a monthly payment equal to the amount of all your accounts in the plan, plus a service fee, and maybe interest if they could not get all of it removed. This should hopefully cost much less than your total payments before, since most credit cards will drop the interest rate to 0.

Notice that no one is lending you money, they are just restructuring your debt, which is safer. Don't confuse these companies with lending institutions, or banks, they are not lenders. Usually car loans, home loans, and other secured personal loans cannot be brought into this type of plan because the bill paying service cannot get banks to relax the interest. This type of plan usually works best on credit cards, gas cards, and other types of credit.

The Proper Way To Use Consolidation Loans

Consolidation loans are not for everyone and can be dangerous if you aren't careful. There's a lot of people who don't pay attention when they consolidate their loans. Sometimes the interest rate can be higher than the total APR on your current debt. Some unscrupulous lenders charge an enormous up front fee that they don't go out of their way to tell you about. Some of these same lenders might even roll the fee into the loan payments. If the loan's APR is higher than your credit cards, you'll lose money and should not close on the loan.

Don't consolidate just for the sake of consolidating. The word is misleadingly dangerous. Your brain tricks you into thinking that consolidation means less. Most people think a consolidation loan means they'll pay less, but that may not be the case. Consolidation just means that the monthly payments from your creditors will be consolidated into one payment to one lender.

Basically you can't just borrow your way out of debt, you must pay it off. A consolidation loan should only be considered if the interest rate is less than all the credit you owe AND you close out all of the accounts you paid off.

Consolidation loans are DANGEROUS for impulsive people because all you are really doing is shifting all your debt from one place to another, effectively OPENING ANOTHER CHANNEL OF CREDIT, while freeing up your credit cards. Some people then proceed to fill up their credit cards again, now they have double the debt they started with, and they are paying up to 22% on their consolidation loan because they weren't paying attention to the APR when they signed up.

Some consolidation lenders are unscrupulous and make it appear they are eliminating your debt, when you are really taking on more debt. They might offer you a lower payment, but check their math and you might discover that it ends up costing you more than your original bills. Don't fall for this! Always check their numbers.

Don't let the lender trick you into thinking that lower monthly payments mean less interest. They could have a high APR and stretch the payments out over a long period of time, which is costing you more in the long run. Car dealers use this trick all the time on car loans. You pay more interest when your payments are stretched out to 60 months.

Examples of Wise Consolidation

Your debts consist of:

gas card with a balance of .$400 at 18%
Master Card balance of...$6,000 at 14%
VISA balance of............... $8,000 at 15.9%, and
department store card of $6,500 at 22%.
You owe a total of.......... $20,900.

Your local bank charges 12% interest for home equity loans and has an $800 loan origination fee. Your strategy might be to borrow $20,900 with an equity loan from the bank to payoff all your balances, and close out the accounts. Now you'll still owe $20,900 but at a lower APR of 12%. Also, at the end of the year, you are usually allowed to write-off the interest you paid, effectively making your APR even lower. Most equity loans are 15 year notes, so try to send in extra principal every month to accelerate that payoff time. Make sure your bank allows pre-payment and extra principal payments.

What if you Don't Have Enough Equity to Consolidate all Debts

But supposing you only have $7,500 equity in your house. How can you consolidate all your debt with $7,500? You can't, you'll have to choose which accounts to payoff. The department store and gas card have the highest APR, so shoot for those. You'll need to borrow $6900 with your equity loan. There is no reason to borrow more, and you should not either.

Sure you would like to buy down some of the interest with your equity, but if you don't have enough to pay it off and close the account, then there is a very high risk that you'll just run the balance back up again. Some accounts you can close, then just continue to pay them off, then you're OK using the remainder of your equity balance to buy down whatever you can on the balance. But we cannot stress the importance enough that you must not let your balances go back up. Consolidation loans and equity loans are potentially dangerous in the wrong hands because you are adding another channel of credit, so use it wisely, and always be fully aware of what you are doing.

If you take out a consolidation loan, consider these simple rules:

NEVER, EVER, EVER, SIGN A CONSOLIDATION LOAN WITHOUT FULL DISCLOSURE IN WRITING OF:

1) The principal amount that you are borrowing.

2) What the interest rate APR will be.

3) How many payments you will pay.

4) Closing costs, if any.

THIS SHOULD BE CLEARLY SPELLED OUT IN THE CONTRACT. IF IT'S NOT ON THE CONTRACT, DON'T SIGN!

If you don't know how to check their math and verify the monthly payments, don't sign the loan papers, you have no business taking out a loan. You'll have no recourse later because in court they'll just say "you signed the loan". Verbal statements or claims made by salespeople do not hold up in court. There are many unscrupulous "lenders" out there who prey on people who are naive or have bad credit. They'll offer you the world to get you to sign up to their program.

If you chose a consolidation loan instead of a consolidation plan, be sure you use the entire amount of the loan to payoff your accounts, and close all the accounts you are paying off. DO NOT keep any cash for yourself to spend. Use all the funds to payoff the debt. No clothes buying, no dinners, no trips, no nothing. Borrow just what you need to payoff your accounts.

Review Of Loans and Consolidations

  • You should never in a million years sign any contract that does not have full complete disclosure of all the facts.
  • Don't start a consolidation loan or program unless the APR is less than your current debt.
  • If you do get a consolidation loan instead of a consolidation program, close all your accounts first.
  • Cancel ALL department store and other retail store cards. Most are at 18%-23% or more.
  • Never pay just the minimum payment. It'll take you years to payoff the debt, and cost you even more interest as the balance accumulates each month. Always send in more than the minimum payment amount, and indicate extra principle on your check for car loans, home loans, etc.
  • Don't be afraid to seek professional help from non-profit organizations. It's not a sign of defeat, it's a sign that you're taking control again and you need help. When you bring your car into a mechanic you're not admitting defeat to anything, you're just going to an expert in the field who knows how to solve your problem. If you have credit problems you need a certified professional in the field of personal finance and credit to solve your problems.

"Consolidation Plans"

Also called Credit Counselor programs, Bill Paying Services, Budget Service Company programs, Consolidation Programs, Reduced Interest Payment Programs, One Pay, or Debt Management Company Plans)

Some debt management company plans are not consolidation loans, they call their product a "consolidation plan" or "bill paying service". They are simply bill paying companies that restructure your debt instead of adding to it with a consolidation loan. The distinction is subtle, but consolidation plans are not loans, they don't lend you any money, you are not taking on any new debt, you just send the monthly payment to them and they pay all your creditors.

With a consolidation plan, the company works as a liaison between you and your creditors, and negotiates with them to reduce or eliminate your interest and late fees, and they are usually successful at getting all the credit cards to drop the interest to 0. This allows the debt to be paid off much sooner, since you are only paying off principal and no interest.

Once you enroll in the program, your creditors going forward are forbidden to contact you. They can only contact your debt manager and not you. You send the bill paying company one monthly payment, and they in turn payoff all your creditors a little bit at a time. Usually when the smallest creditor is paid off, more cash is available to be applied to the remaining creditors, paying off those balances even more rapidly.

All the companies require your payment in money order form only to guarantee that you'll never bounce a check, because they just forward the funds to your creditors. If they allowed you to mail in a check and it bounced, you might anger some of the creditors into kicking you out of the program, then you're in trouble, because you interest shoots back up to 18% or whatever it was before.

There's Profit, and Non-Profit Companies

Some of the "for profit" companies charge between 1 - 5% of your monthly payment as a service fee. The "for profit" companies usually have up front fees before they'll even take you on as a client. Sometimes the fee is refundable after 30 days if you decide not to enroll, sometimes you'll lose the fee, and sometimes it's refunded at the end of the program, usually 48 months.

In Indiana a "Budget Service Company" may charge up to 15% of the total amount the debtor agrees to pay through the licensee divided into equal monthly payments over the term of the contract. There is a maximum initial payment of $50 which is deducted from the total contract fees. If you quit the program before it's over (very foolish), all fees are non refundable.

The non-profit organizations like the Debt Assistance Reduced Interest Program might only charge a $25 monthly fee or less to cover administrative costs. Many of your fees may be optional with non-profit organizations, because many costs are paid by pools from all the creditors, as well as other resources. Sometimes you only have to pay them if you can afford to. Usually it will cost you less to deal with the non-profit organizations than with the "for profit" companies.

Naturally, the "for profit" companies will try to talk you out of dealing with the non-profit organizations, scaring you with tactics like pointing out the fact that most of your fees with non-profit companies are paid by the creditors. Because of this, the "for profit" companies claim that the non-profit organizations are not acting in your best interest. However, you will still end up paying less. How can that not be in your best interest? Your up front fees with non-profit organizations are either cheaper or non existent, and your monthly payments may be lower also because they have lower per month fees.

Both types of companies whether they are "for profit" or not, all arrive at the same goal for you: getting your creditors to drop your interest to zero so you can just payoff the principle. It's not the balance you owe that's killing you, it's the interest. Debt consolidation companies have agreements setup with over 3000 creditors, and are more influential with them than you are. You may not be able to convince all your creditors to reduce the interest rate on your own . Most creditors are willing to drop the interest rate, and late fees because it usually means they'll recover their investment in you instead of writing off a loss, or wasting more money on collection agencies to hound you.

But usually one of the requirements of reducing the interest is that you must close all the accounts that you are consolidating. You are usually required to send your payments to the debt management company in cashier's check or money order. Some organizations can also do electronic funds transfer. Never send cash, it's not traceable. With all the accounts the debt management companies maintain, it's hard to verify that all our checks are good, so they all want money orders.

WARNING: It may appear on your credit report that you are working with a credit counselor or debt management company. No company can tell you this won't happen. It's up to the individual creditors to decide whether the information should appear in your credit report. No matter what your debt manager tells you, they have no control over this.

Some IRS approved non-profit companies don't require any money up front from you. They are much better than most payment plans, because you can check your current balances anytime by logging into their website. They are paid by the creditors in the program, and also receive money from any books and downloads you might choose to buy from their website, and by the optional donation you pay them when you sign up (usually $60). That's a lot cheaper than the $300 that the profit oriented "bill payment" companies demand up front.

Up Front Fees:

Handling the up front fee is tricky. Some non-profit organizations usually allow you to enroll without paying this fee. But the profitable companies will ask you to send them a money order for $300 or more before they even take you in as a client. This is because they need to get all your account statements and balances and contact information to check with all your creditors to see who will drop the interest to 0%, and who will participate in the program at all. Car loans and home loans are out.

This preliminary work takes time and resources on your debt consolidation company's part, so they want a some compensation up front. However, some of them are quite lacking about disclosing to you IN WRITING their complete user agreement until you have sent them your money. This is completely unfair and insulting to you and you should not sign up unless they have sent you at least the verbiage of what their final agreement is. Non-profit organizations usually have their agreement contracts online for you to read before you send them one penny. We're not talking just marketing sales info, look for the actual legal agreement, which is usually found at the end of the enrollment page before you submit.

The reason you want to read this agreement first is maybe there is something there that you disagree with and would not sign. But some of the profit companies take your money order first, then send you a proposal with the final agreement. Then you see something you don't like on the contract, the company begins to give you a bad feeling, and you want out. But you might lose your fee even though the salesman may have told you your up front fee is refundable, he did not tell you it's only refundable at the end of the program 48 months later. Quit now and you forfeit your deposit. This is why it's so important to get everything in writing before you enroll.

About Your Monthly Payment Quote: The Catch 22

When you first contact these companies to determine what your monthly payment will be, they can only estimate how much you'll actually be paying, because they do not accurately know all your balances. You may think you know your balances, but when you send in your statements, they discover your balances are more than you told them, and that will jack up your payment from their original quote.

You have to send them your latest bill from each creditor, then they have to call them up and see who will participate in the program, and who will not, then once they have heard back from all your creditors, they can add it all up and tell you what your monthly payments will be. This is sort of a catch 22 for you because you don't know if you want to enroll with this company, yet they can't get you started without a deposit, so you have to send money to a company that you might not want to sign with. This is why we recommend the non profit organizations, because they either charge a small fee to get started, which is way cheaper, or sometimes no fee at all.

NEVER agree to enroll in the program until you have seen a contract specifically detailing YOUR entire consolidation program, including a listing of all the accounts and balances in the program, the interest if any, what your monthly payment will be, HOW MANY MONTHS, and any other little fees that they sneak past you. Any reputable company should give you your deposit back within 30 days if you don't enroll. At the very least you should get some of it back. If you do not a written agreement, DO NOT SEND THEM MONEY! Assume every penny you send them is completely non-refundable. You need to know what accounts they are claiming will be paid under this program. If they don't itemize this, don't sign up.

TIP: When you itemize all the accounts you want to be included in the plan, make sure you have all your ducks in a row and give them all the information they need in one shot. Don't go back to them after they went through all the trouble of determining your monthly payment and add another account to the pile. They'll have to start over, that will increase your payments, accusations will fly, and it just becomes a big pain in the neck for everyone. Do your homework first, and send the consolidation company one packet containing everything they need to get started. Don't spoon feed them information, as time is of the essence.

Some debt consolidators have clauses written into their contracts that say "You agree to hold us harmless....and you will not file any lawsuit against us". DO NOT sign the contract if this clause is present. This means they can stop paying your creditors, you get in big trouble, and you can't sue them for it. Just move on to the next company that does not have this clause. But this clause is OK if it is qualified with the statement "unless we are negligent or commit a crime..." Then it means you can sue them doing you wrong.

Do not sign their contract unless you agree with everything in it.

See Web Site on Choosing a Credit Counselor