Debt Is A Trap

With so many upheavals happening in Americans’ financial lives, it is no surprise to me that a huge number of questions brought to me are targeted around debt consolidation.  What is debt consolidation?  In a nutshell, it is when you combine multiple debts into one large loan with generally a longer term in order to manage the payment.  A big funnel that a lot of people swirled down including myself about ten years ago, was to take a second mortgage against the equity in our homes in order to eliminate the mounting credit card debt.  Yes I agree, you can write off the interest from your mortgage against your taxable income, but you still have compromised what is more than likely the largest asset you have invested in, the roof over your head.

The most common reason that people seek consolidation is that they are so deep in payments that they are feeling the pinch.  That, like any pain, should be serving as a warning sign of a larger problem growing in the background.  The reason banks were so willing to hand out second mortgages and lines of credit ten years ago was because the value of property was stable, business was stable, and in order to show growth they needed to generate consumer expense, increasing interest revenue was an easy way.  The problem is that most individuals, even if they were lectured by lending agencies and accountants to reduce spending and buckle down, they returned to their past spending habits in a few short months.   Thus returning to their previous level of unsecured debt  and now its added to a first and second mortgage and there is no new equity to loan against.  As a matter of fact, millions of people have found that they are in a negative equity situation.

Equity, (a word most of us are not fortunate to have in anything we own) is when we owe less money on an object such as our homes, than it is valued at.  Now, I was fortunate when I had my awakening into the debt world, I sold my home using the equity to clear a lot of my debt.  That was before the values of real estate dropped an unheard of 20% in some markets.  What that means is that those who worked hard and took out a traditional mortgage of only 80% of the value of the property….. lost that money.  Yes, gone.   Didn’t think they could just change some numbers and take it away did you?  Me either.

Now lets look at the poor souls who trusted their mortgage company and loaned out from 80 to 100% of their homes value.  Take the 20% hit and now, these people owe an aweful lot more on their home than its worth.   I personally am not banking on the value of real estate to return to the same level as before.  It’s my personal opinion that in my own area, the prices were inflated by a good economy and greed.  Now, as with everything in the world, the economy is trying to return to a balance.  If a person owed a home valued at$200,000 and they were mortgaged to 95% of the value, their mortgage amount is approximately $190,000.  Now hit them with a 20% decline in value $40,000, their home is now worth $160,000.  Leaving them owing $30,000 more than it is worth.

Now that we have looked at that situation, back to debt consolidation.  Debt consolidation companies factor many things into approving you for a loan.  With the economic situation as it is, I have very little doubt that any lender is going to require equity for such a loan, and lets face it, there is very little to be had.  The lender is also going to look even harder at why you are trying to consolidate.  They have tightened their purse strings and its unfortunate but its because they were so free with lending in the past.  So it is my opinion that obtaining a consolidation loan is risky at this point and should be though of as a last resort, if there is one available to you at all.  If payments are drowning you, contact each creditor, explain your situation and try to reach the most optimum outcome for both of you.  Repayment in a way that you both can live with.

Ultimately we have to begin spending less than we earn.  Very few have the fortunate circumstance to be debt free.  It is our own over the top spending that has built the debt, now it will be under the take home pay living that pays it off.  Every bill, every creditor, every day, ensure the open communications with banks and creditors.  As my favorite scholar once said. “Creditors have better memories than debtors.”  Poor Richard’s Almanac.  And they never miss a due date.