Debt Consolidation

Like bankruptcy, debt consolidation should be the last option for you to consider. Debt consolidation involves the merging of high-interest debts and lines of credit into a "secured" loan with a more favorable interest rate. The loan is typically a home equity loan, otherwise known as a second mortgage loan. For the borrower, the benefit of the loan is to consolidate debt loan with a lower, more manageable monthly payment. There are also some tax benefits. However, the risk of acquiring a debt consolidation loan is the tradeoff of multiple "unsecured debts" for a "secured debt."

In exchange for a debt consolidation loan, a borrower must pledge the equity in his home as collateral for the lender. The collateral would guarantee loan repayment to the mortgage lender. Thus, if the borrower defaults on the loan, the lender could foreclose on the borrower's property to collect the outstanding debt.

Getting a debt consolidation loan can be a dangerous approach. Statistically, "75% of the borrowers that have received a home equity loan have ended up in MORE debt than they previously had." This happens because lenders entice borrowers to take out debt consolidation loan amounts based on the maximum equity of their homes instead of the lower amounts needed to consolidate their debts.

• Example: A borrower needs to consolidate six credit card accounts totaling $20,000. However, based on the borrower's home equity, the lender entices the borrower to take out a $50,000 home equity loan. The borrower uses the line of credit to pay off the $20,000 credit card debt. From the $30,000 line of credit that is still available, if the borrower later decides to get cash out to fund a vacation, make home improvements, or purchase a car, he will sink deeper into debt.