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17-04-2006
Avoid variable-rate debt consolidation loan
Dear Debt
Adviser,
One of my
credit card companies has a debt consolidation loan that would allow
me to pay off my credit cards in five years at a variable rate of 7.24
percent. As the minimum payments on a couple of my credit cards have
jumped to a level such that it is now a struggle to come up with the
extra cash, I am definitely considering this offer. Is this a good
idea?
_ Laura
Dear Laura,
You will be
well-served to look at this offer from all sides before you accept it.
Here are three
key items to consider:
1. The interest
rate is variable. The term "variable rate" should scare the pants off
you when it comes to a loan and you are in a position of having
trouble making all of your payments. Remember, the credit card company
is providing you with a service that, at first glance, looks like a
lifesaver; however they are in business to make money and the ability
to change your interest rate (with the word "variable") is one of the
ways they can and likely will. Further, variable rates are tied to the
prime rate and it has been steadily rising and may also make your rate
upwardly mobile. I recommend taking a closer look at the offer. What I
believe you will find is language in the loan agreement that states
the creditor can change the credit terms at its discretion.
2. You are having
trouble with your current minimums. You are having trouble repaying a
loan that likely is already amortized over eight to 10 years. The
minimum payment rules changed at the beginning of 2006 requiring that
a minimum payment has to cover interest, fees and allow you to pay off
the loan in a reasonable amount of time. The bank decides what is
reasonable, and it is usually between eight to 10 years. If you go to
a five-year repayment period, your monthly principal amount will have
to increase. A temporarily lower interest rate may make the payment
lower, but that may change with the variable interest rate. The
five-year term will not.
3. Is there a
penalty-rate clause in the terms? Check out the fine print relating to
universal-default terms and the penalty rate on this card. Some cards
use a universal-default provision that says if you are ever late on
any obligation, even to another lender, the company can charge you a
penalty rate. Some can even do it if your credit score deteriorates
but you are never late. Penalty rates vary by card issuer, but as of
this writing, some large issuers, including Citibank, Chase and Bank
of America, charge 31.5 percent! Add that to a five-year repayment
scheme, and you will be wondering what hit you.
Still, if the
offer checks out, it may be a good one to consider. A last suggestion
is to go to your local bank or credit union, bring the offer and see
what they will do for you. You may be surprised at the result.
I don't want you
to be put in the position of believing that you have your debt under
control with the debt-consolidation loan and then have the rug pulled
out from under you if your creditor increases your interest rate and
your monthly payment increases to an amount you cannot afford. I
encourage you to explore all your options before consolidating your
debt with this or any creditor's offer.
Whatever you
decide to do, stop charging and examine your monthly spending to make
sure you are not overspending on nonessentials.
Good luck!
(The Debt Adviser,
Steve Bucci, is the president of Money Management International
Financial Education Foundation and the author of "Credit Repair Kit
for Dummies." Visit www.moneymanagement.org or call 877-311-2227 for
additional debt advice.)
Source: Roseville and Rocklin
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