The Problem of Unsecured Debt
Unsecured debt, unlike secured debt, is debt without collateral. A creditor who provides an unsecured loan assumes a risk that the borrower won’t be able to pay back the loan, in which case the creditor gets nothing. Because of this risk, creditors often charge much higher interest rates on unsecured loans as opposed to secured loans. Consequently, it’s no surprise that people often get in over their head with unsecured debt. If you are on the verge of delinquency or bankruptcy because of unsecured debt, read on for more information on how to eliminate unsecured debt.
Tapping Your Home Equity
If you’re a homeowner, you may be eligible for a home equity loan, or home equity line of credit (HELOC). Eligibility for these loans, of course, requires that you have home equity, meaning your home must be worth more than you owe on it. Perhaps more crucially, most home equity loans also require good to excellent credit history. Accordingly, home equity loans are not an option for many people who find themselves in difficult financial situations. Nevertheless, if you can qualify for a home equity loan, it is an appealing option because of the low interest rates generally associated with such loans (usually around 8%, compared to the 15-20% charged by most credit cards) and the single monthly payment. Moreover, the interest you pay on home equity loans is generally tax-deductible. Keep in mind, however, that taking out a home equity loan does not actually eliminate debt. On the contrary, a home equity loan may actually increase or extend your debt by shifting your debt from several high-interest accounts to a single lower-interest account.
Recently, many people have been using home equity loans to consolidate their credit card debt. On the one hand, obtaining a secured loan such as a home equity loan is preferable because it enables you to obtain a lower interest rate. On the other hand, you run the risk of losing your home if you fail to make payments on time. Thus, non-homeowners and homeowners alike sometimes elect to take out an unsecured debt consolidation loan to reduce monthly payments. Approval for an unsecured loan is based on a combination of your income, credit and payment history (FICO score). Consequently, unless you have exceptionally good credit or a family member who is willing to co-sign, unsecured loans can be hard to come by. If you do get approved for an unsecured loan, it will likely come with a high interest rate.
The bottom line is, you may not save any money in the long run, nor will you eliminate your debt any faster if you elect to take out a debt consolidation loan with a high interest rate. Rather, by “robbing Peter to pay Paul,” you will have simply replaced your old debts with new, longer-term debt. Additionally, because debt consolidation results in the closing of several old accounts (which have been absorbed by your new lender), it could actually have an adverse effect on your credit score, which takes into account longevity of credit history.
Despite the recent surge in the number of bankruptcy filings each year, bankruptcy remains the least favorable way to eliminate unsecured debt. This is due to the many drawbacks associated with bankruptcy, among them feelings of shame/embarrassment and a destroyed credit score. Unlike debt consolidation, which may negatively impact your credit score in the short term, bankruptcy remains on your credit report for 7-10 years, making it difficult to obtain new credit.
The Preferred Way to Eliminate Unsecured Debt: Debt Settlement.
Because of the nature of unsecured debt, debt settlement is often a practicable solution to eliminate it. Creditors, cognizant of the fact that they will end up with nothing in the event that you file bankruptcy, are more willing than you’d think to negotiate settlements. Indeed, creditors have been known to settle accounts for fractions of what is allegedly owed. The key is in knowing how to negotiate with your creditors. Of course, you will also have to be diligent about documenting and recordkeeping. For this and other reasons, many people prefer to hire a professional to handle the negotiations and settlement process. If you do choose to hire a third party to do the negotiations for you, be sure to do your research beforehand, as there are many illegitimate companies out there looking to exploit consumers burdened by debt.
McCarthy Law PLC is a debt settlement law firm with offices in the Los Angeles, San Diego, San Francisco, and Phoenix area. If you have questions or would like to speak with an experienced debt settlement attorney, give us a call today for a FREE consultation.