Combining debts: Win or lose?

Posted: Jan 02, 2007 12:00 AM

First of all, let me take this opportunity to wish you and yours a very Happy New Year! I appreciate the opportunity to share with you the experiences that I have collected over the years in my profession, and I am even more grateful for your listening ear. I have enjoyed our conversation over the last six months, and I look forward to continuing it as we roll into 2007.

Now, I spent most of the year in 2006 talking about rolling your debts into a new mortgage on your home and winning in several ways. I am finding that most of the major lenders who advertise on television are now saying the same thing (almost) and setting people up to lose. Why would they do that? Well, to be blunt, P.T. Barnum said "there is a sucker born every day", and while that's an easy assumption to make, I am not of that school. Based on my observations of the people I interact with on a daily basis, I believe people are hurting and either can't or don't want to search for the solution but instead will take anything that will appear to alleviate the pain. I believe this is the basis for drug addiction (not my field). In any case, it is time to take a look at the various ways to tackle the same problem.

There are three main ways to tackle the problem many people find themselves facing: too much debt and not enough of anything else (liquid assets) to make it disappear. I am particularly aiming this discussion at homeowners who at least have one asset that can help: their home. The most obvious solution when the bills are becoming too large to handle (as defined by the payments you need to make on them each month) would be to roll them into a new mortgage, in most cases, and hope this is the answer. Your second choice would be to seek help from a credit counseling institution or the likes and, in many cases, running the risk of ruining your credit. Your third choice would be to cut out your desire for using plastic and do nothing to remedy the problem immediately. If I were to stop here, I can tell you a certain segment of the readers would opt for the third solution--hands down! I am not quite sure that they could do it for themselves, but they always tell me that that's what they should do--always!

Let's look at the solutions in reverse order. People in the United States of America have increasing amounts of debt as new records are set monthly in the credit card industry for the ever increasing debt burden we place on ourselves. What's the reason? We, without exception, and definitely including me, are susceptible to advertising which comes at us from every angle. We now have sponsors for everything including football games: the (blank) Orange Bowl game, etc.

In addition to the advertisers running a muck, I am not sure what happened to the usury laws, (the ones that stated that a company could only charge so much interest.) Some how, the credit card companies do not seem to be abiding by any laws at times whatsoever. Credit card companies charge anything from 0% up to 33.33% on your balance. If you are a day late on the 0% card, when the total balance is due, you might find out you are paying the 33.33%.

Rather than focus on the external factors, let's return back to the original discussion of running up the debt in the first place. There certainly is a percentage of the population who simply have no restraint and while at the same time, they have good enough credit to really get themselves in trouble. It isn't everyone, of course, and it is continually becoming a smaller percentage of those in trouble. The real internal issue to this problem and the largest contributing factors to this list seem to be the following: loss of a job, a disability, an accident or illness, or just plain poor financial decision making. I see this in the thousands of emails I get every month.

The problem can start small, but if you do nothing, it grows exponentially all by itself. When you fall behind on your debts, you add late payments to the mix as well as continually higher interest payments. At some point, you find that your balances, keep going in the wrong direction much faster than they ever dropped. I do not believe we are in a "do nothing" environment that would allow a "do nothing" solution to remain feasible--not with gas prices on the way up again, rents rising and wages growing at a pace that barely keeps up with inflation.

What about seeking help through credit counseling? While that may appear to be a decent solution, that may not be the best solution for you. Credit counseling, while it can cut out much of what you owe to your creditors, can sacrifice your credit in the short to medium term. It wouldn't be my choice.

This brings us back to the option of your house as a solution. Rolling your debts into a new mortgage can be a major win for you if you do the right thing for yourself--take a shorter amortization than what you currently have. It can, however, be a setback for your finances if you take the wrong loan: one equal to or longer than your current loan. The latter is the one being advertised today by all of the major lenders. Why? It's an easier sale for them. How many times have you heard someone in an add say "if we can save you money, you know it's the right loan for you"? Now, contrast that to "if you do shorten your amortization, you will save a little money monthly, but the real savings will be the money you will have in the long run by foregoing years of payments on your mortgage". Some how, the thought of saving years of payments in the future doesn't have quite the same ring.

The motivation to take a shorter amortization is, in "short", the ability to take a less than perfect situation and make it work for you. If you take your short term debts and roll them into your new shorter amortizing home loan, not only does your balance amortize quicker, (paying down an amount equal to or greater than you owe in the short term), it also saves you years of payments as well. This will not happen if you take the same or a longer amortization when refinancing your short term debts with your existing mortgage.

I have watched the differing results of the short term amortization versus the long term for several years now, and I have found that the above statement rings true. On the other hand, while rolling short term debt into a long amortizing home loan can be a quick savings in the short term, it can be a significant cost in the long term. While it isn't easy to change your "modus operandi," it should be something you are willing to consider.

Moral of the story: please examine all of the possibilities before acting and perhaps your first decision of the New Year can be the one that makes 2007 your year!