CHAPTER #29 Which is Better: Bankruptcy or Bill Consolidation Loans?

Bankruptcy is usually always better than a bill consolidation loan. You owe it to yourself to discuss your situation with a bankruptcy lawyer before you make a bill consolidation loan. (A loan is different than going to a counselor who advertises "bill consolidation." See the next Chapter on "Bill Consolidation.")

I recently interviewed a lady who could have done a Chapter 13 and paid her debt at no interest over 60 months. Instead, 7 months before she saw me, she made a bill consolidation loan secured by her house, paid the bills, and gave some money to her children. She now cannot afford the payment on the bill consolidation loan, and since it is a second mortgage, she will have to struggle with the payment, which is too high, or will have to sell her house.

Not only is the second mortgage payment too high, but it will last over 10 years, twice as long as the Chapter 13, and she will pay twice as much as had she done the Chapter 13. Not only that, but her loan contained a "negative amortization" provision, which raises the cost of the loan if it is paid off early.

This could have been avoided had she gotten her bankruptcy alternatives before she got a bill consolidation loan. Even bill consolidation loans that are not mortgages, rarely are a good idea. They don't "save your credit rating", because you are reported as owing a lot more money than if you had just done a Chapter 7. Of course, there are exceptions.

Be careful about bill consolidation loans, especially if you are putting a second mortgage on your house. Consumer finance companies are private operations that lend money to the public. They usually charge much higher interest than other lenders, such as banks and credit unions. They will lend more money, and to worse risks, than other lenders, so they must get more interest to cover their potential losses. If you have a loan from a finance company, you are probably paying two to four times the prime rate of interest. The prime rate is the interest rate charged to the best customers of the biggest banks. Look on your contract, if you have one, and see how much interest you are paying.

These consumer finance companies often advertise "bill consolidation loans." These companies are not stupid. They know that anyone who is looking for a loan to pay other bills is already in trouble. They are not going to make a loan to a person who has such a problem without being careful.

Before a finance company will make such a loan, they will require a full disclosure of all the creditors to whom you owe money. Many people who come into my office for a bankruptcy try to avoid telling me all their creditors. They say "I want to keep my car off", or something like that. If you lie to a consumer finance company when you are asking them for a bill consolidation loan, you may be committing fraud, and fraud is not dischargeable even in bankruptcy, which gets rid of most mistakes. So you must give a full and complete list of all your bills, and often the finance company will make you sign it under penalty of perjury.

If you are truly making a bill consolidation loan, and the finance company has a list of your bills that you already owe, they will want to make the check payable to those creditors. They are not going to give someone the money and trust them to pay off the existing bills. The temptation to spend it is too great.

You still owe the same or a greater amount of money after a bill consolidation loan, and have probably converted unsecured debt into a debt with collateral.

The greatest danger in a bill consolidation loan is that consumer finance companies do not like to make unsecured personal loans of amounts over $5000.00. If you want to borrow a substantial amount, you will have to put up "collateral", or secure the loan by giving the finance company an interest in something of value you already own.

For example, if you own a house worth $75,000.00, and only have a $40,000.00 mortgage, you have about $35,000.00 in "equity", which is your interest in it. If you sold the house, you would pocket $35,000.00 less the cost of selling it, and commissions to real estate brokers. If you want to make a home equity loan, you can generally borrow up to 70% of the value of the home. 70% of $75,000.00, in this case, is $52,500.00. Since this house already has a loan of $40,000.00 in it, about $12,500.00 is available for you to borrow.

If you borrow the $12,500.00, and use it to pay off your unsecured creditors, you then will have one payment to the finance company, and on repayment to your regular mortgage company. This may not be a bad idea if you have a lot of equity in your house, especially if you can get a second mortgage at a rate of interest close to 10%. If you pay off more than $12,500.00 in charge cards that you were paying 20% interest on, it can save some money.

However, if you were to simply knuckle down and pay the charge accounts, you would pay a lot less in interest, because they would be paid off in a much shorter period of time. A Chapter 13 could pay off the credit cards in one installment each month for all, at less or no interest. The bill consolidation loan, or second mortgage, will be around for 8 to 10 years.

An experienced bankruptcy attorney can advise you whether or not you should get a bill consolidation loan, or whether you should just continue to struggle with your bills, or whether a Chapter 13 or Chapter 7 bankruptcy would be more to your best interest. The problem comes in where you go and make the bill consolidation loan without getting any disinterested or competent advice, and then come in to the attorney after you have made the loan. There is no way to un-make the loan, or to reduce the payments, once you have made it. Get advice from a bankruptcy attorney before you make additional loans.