Getting the goods on debt consolidation

The flailing economy is forcing many Americans to take a closer look at their financial situations, including the amount of debt they're carrying. CNBC reported that "total credit card debt reached a record $930.6 billion in the fourth quarter of 2022, according to the latest credit report from TransUnion."

What is debt consolidation?

As you look for ways to save money and reduce financial obligations, debt consolidation can seem like the perfect answer. When people speak of debt consolidation, what they usually mean is payment consolidation. This means your payments are consolidated into one monthly payment, but your debts remain with the original creditors. Representatives of the credit counseling agency negotiate lower interest rates and manageable monthly payments with your creditors. Then, you make one monthly payment to the credit counseling agency, and the agency distributes the money to your creditors.

Choosing a debt consolidator

Promises to "erase your debt in one click" and to "get on the road to debt-free living" can sound great, but the first rule of finding the right debt consolidator is this: If it sounds too good to be true, it is. You could end up being charged higher interest rates than what you have on your existing debts. Debt consolidators often put their own fees into your "one low monthly payment," and those fees can be as much as 10% of your payment. Before you choose a debt consolidation program, it is imperative to understand what you are getting into.

So how do you determine which debt consolidators are legitimate?

What to look for

Seek advice from independent (repeat, independent) organizations designed to help people in debt. The National Foundation for Credit Counseling (NFCC) is a non-profit group that provides free and confidential debt advice. It offers web-based services and has over 100 member agencies and more than 900 local offices throughout the country. Through the NFCC, you can get budget counseling, debt management plans, financial counseling referral services, and homeowner counseling.

Check for accreditation. The NFCC or the Association of Independent Consumer Credit Counseling Agencies (AICCCA) can help you find an accredited credit counseling firm to manage your debt consolidation.

What to avoid

There are many options available for consolidating your debt, and the organization you choose can have a significant impact on the health of your credit score. With any credit counseling or debt consolidation agency, look for these red flags:

1. Are there up-front fees? Beware of high set-up fees, especially those over $50. The bigger the set-up fee, the bigger the red flag. Unless you are getting an extra service that justifies a high fee, you are likely dealing with a less-than-legit organization.
2. Are they promising things they cannot deliver? A legitimate credit counseling agency will help you conquer your debt while acknowledging that they cannot fix everything. Any debt you have accrued will still be reflected on your credit report—no credit counselor can change that.
3. How much of your monthly payment will go to your creditors? Determine how much of your monthly payment is paying down debt and how much is an agency fee. If your agency is getting more than your credit card company, you may be in trouble. Some agencies take your first month's payment as their fee. And if you miss a payment with your credit card company, it will throw your credit score into deeper upheaval.

Don't let unscrupulous debt consolidators keep you from addressing a debt problem. There are great debt solutions out there. Just be sure you get the real story about the debt consolidator you choose to use.