Debt Consolidation: Understanding Credit and Debt

Debt consolidation involves transferring the balances from multiple accounts with relatively high interest rates to one account with lower interest. A debt consolidation loan does not reduce debt so much as restructure it in beneficial ways.

Types of Debt
Debts are either secured or unsecured. Secured debts are tied to a tangible asset like a car for a car loan or a house for a mortgage. If a borrower stops making payments, lenders can repossess the car or foreclose on the house. Unsecured debts are not tied to an asset. The most common types include credit cards, medical bills and signature loans.

Debt and Credit
Most people get into debt difficulties because credit is easy to get and hard to control. Here are some “warning signs” that debt ┬ámay be getting out of hand:

The rule of thumb when using credit is known as the 20/10 Rule: Don’t borrow more than 20% of your annual net income and don’t let your loan monthly payments get higher than 10% of your monthly net income. For example, if you take home $4,000 a month, your total payments on credit debt should be no higher than $400 (excluding your mortgage and second mortgage).

Dealing with Debt
If you are in financial trouble, here are three things you can do:

Develop a Budget: Start by listing your income from all sources. Then, list your “fixed” expenses like mortgage payments, car payments and insurance premiums. Next, list the expenses that vary like entertainment, recreation and clothing. This is a helpful way to track your spending patterns, identify necessary expenses and prioritize the rest. The goal is to make sure you can make ends meet.

Contact Your Creditors: Contact your creditors immediately if you’re having trouble making ends meet. Tell them why it’s difficult for you, and try to work out a modified payment plan that reduces your payments to a more manageable level. Don’t wait until your accounts have been turned over to a debt collector. At that point, your creditors have given up on you.

Don’t Be Intimidated by Debt Collectors: The Fair Debt Collection Practices Act is the federal law that dictates how and when a debt collector may contact you. A debt collector may not call you before 8 a.m., after 9 p.m., or while you’re at work if the collector knows that your employer doesn’t approve of the calls. Collectors may not harass you, lie, or use unfair practices when they try to collect a debt.

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