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Consumer Watch: How to find the right path out of financial trouble

Jun. 21, 2012 - 01:46PM   |   Last Updated: Jun. 21, 2012 - 01:46PM  |  
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If you go about debt consolidation the right way — paying off your bills and reducing your interest charges — you'll save money and improve your financial future.

Do it the wrong way, and you'll spend more money and damage your credit score.

First, think about why you want to consolidate. You may be better off putting as much money as you can each month toward paying off one credit card at a time, rather than racking up more debt.

Indeed, the general advice of myFICO, the company that developed the FICO score, is to pay off debt rather than move it around, said spokeswoman Jennifer Samuels. FICO scores are used by lenders to determine the creditworthiness of borrowers, pulling information about payment history, amounts owed and other data from the credit reporting agencies.

If you do choose to get another loan to consolidate your debt, you don't have to close your other credit cards. Owing the same amount but having fewer open accounts may damage your credit score, Samuels said. And if the transfer leaves you with more available credit, she added, don't revert to bad habits and charge it up again.

If you do decide to consolidate, here are some points to ponder:

Know your options

Research the best kind of loan for your needs, starting with your bank or credit union.

Leverage your home. If you own your own home and its appraised value is more than what you owe on your mortgage, a second mortgage or a home equity line of credit might be possible. You must put up your home as collateral, though — if you miss payments, you could lose it. This kind of loan has tax advantages, but the interest charges can still add up, especially if the loan is paid back over a number of years.

Credit card transfer. You could transfer credit card balances to a card with a lower interest rate. But read the fine print first: If it's a teaser interest rate — zero percent for a year, for example — make sure you can pay off the balance in that year before the rate spikes.

Personal loan. A personal loan may be available through your bank or credit union. A number of military-affiliated institutions offer these loans. For example, as of this writing, Pentagon Federal Credit Union is offering an online-only consolidation loan through June 30 at an annual interest rate of 8.99 percent, with terms of up to 60 months. These personal loans often have higher interest rates because no collateral is required. Make sure the interest rate on a new loan is lower than the interest rate you're currently paying on the debts you're trying to consolidate.

On any loan, never sign anything unless you get a statement in writing clearly showing the interest rate, term of the loan, amount of the monthly payment, total amount of interest you will pay over the life of the loan and total amount of money you will pay back.

Beware promises of an easy fix

Be careful about companies advertising to "call us and we'll get rid of debt," said Mechel Glass, vice president of community outreach for CredAbility, a national nonprofit credit counseling organization.

The Internet is full of land mines, too. Google will bring up online payday lenders, "military installment loans" and "military debt consolidators." The costs of these loans can be high — in some cases, the interest rate is higher than 500 percent. Check out companies with the Better Business Bureau and with your state attorney general's consumer protection agency.

Remember that debt consolidation is different from debt settlement — settling the debt for less than you owe, which can harm your credit score, Samuels said.

Some companies may require fees of $2,000 to $5,000 for "debt settlement," Glass said.

"You have to question, ‘What is the company going to do for me? What can I do for myself?‘" she said.

Some companies can also hurt your credit score with delayed payments, she said. You may give them a monthly payment and expect them to send it to your creditors, but they don't. "They're holding the dollars until they accumulate enough so that they can call and negotiate a settlement for a smaller amount," Glass said. "Meanwhile, your credit is being damaged."

Get real help

For help in managing your debt, contact personal financial management counselors at your family center on base, through http://MilitaryOneSource.com">MilitaryOneSource.com, or through the National Foundation for Credit Counseling.

Using a credit counseling service's debt management plan, in which you make monthly payments that the service sends directly to your creditors, should not have any negative impact on your FICO score, Samuels said.

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