Should You Lump Credit Card Debt Together?

Jackie Fox, who is juggling about $8,000 in credit card debt, thought she might be able to scramble out of her debt hole by signing up for new credit cards that offered introductory interest rates of zero percent.

In an e-mail to Good Morning America's Financial Contributor Mellody Hobson, Fox asked whether switching her balances from one card to another one that offers zero percent introductory rates was a wise thing to do.

"Is this a good thing or should I leave them on the card with the lowest APR?" wrote Fox, a 36-year-old welfare-to-work mentor. "Help!!!"

Her confusion is typical. Since the average American household owes about $8,400 in credit card debt, it's no surprise that millions of debt-wracked consumers are turning to the debt consolidation offers jamming up their inboxes and mail slots.

Debt consolidation is one of the fastest-growing industries in the United States, where credit card debt is increasing faster than any other form of debt. Americans now owe a record $1.7 trillion to credit cards, department stores and automakers.

But anyone considering debt consolidation should be aware of the pitfalls in everything from low-rate credit card offers to debt consolidation companies, Hobson said.

A Credit Card Ploy

In Fox's case, she should let those tempting zero-percent credit card offers pass her by, Hobson said.

"It's such a ploy that some of these credit card companies use. The zero rate is a teaser, generally for no more than six months, so it's short-term, not a solution," Hobson said. "Unless you know you're going to get a big load of money shortly, say in the form of a big raise, inheritance or something, you're in a worse situation. Because all that money's coming due at a certain looming date, back at a high rate."

Hobson recommends leaving the debt on the card that has the lowest annual percentage rate. Taking up zero-percent offers leads to opening more cards, and building up new charges on them, she said.

Brigidanne, a 37-year-old single woman from Newburgh, N.Y., also had a consolidation question.

"Which is the lesser of two evils — going for debt consolidation, or getting a loan for this purpose at a high interest rate?" she asked. "I would like to reduce the 'just squeaking by' scenario I am currently in."

There are two options most people consider, and both contain perils, Hobson said.

Consolidation Loans: A consolidation loan combines payments on other loans, so you've got one monthly bill to the lender, ideally at a lower percentage rate.

Consolidation Plans: The debt consolidation agency becomes a bill-paying service that works with creditors to reduce or eliminate interest and late fees in exchange for making a payment every month. In exchange for this service, the consumer pays a monthly lump sum plus a service fee to the agency that then distributes the payment to your creditors. No money is loaned; rather, your debt is restructured. This type of plan is suitable for unsecured loans such as credit cards, and usually lasts three to four years.

Hobson has cautious words for both courses of action.

"An important thing to know is that once you work with a counseling or consolidation agency, it may show up on your credit report," Hobson said. "Another key thing to remember about loans is that the most dangerous debt consolidation loan is a home equity loan that uses a borrower's house as collateral. It's a huge risk because of the potential for foreclosure."

Many companies providing consolidation loans offer only short-term low interest rates. In other words, if you do not pay off the debt in full by a certain date, they raise the interest rate back up to the average rate of 18 to 20 percent. Finance companies that deal primarily in debt consolidation loans are among the worst options for consumers in need of a loan as the fees are often enormously high, Hobson said.

Before seeking a debt consolidator, contact your creditors to negotiate a management plan and a lower interest rate. Remember, you lose the ability to negotiate with your creditors once they turn your debt over to a collection agency. More importantly, commit to changing your buying and borrowing habits before taking on any additional loans.

Roll Loans Onto Credit Cards?

Michael LaPorte, a 33-year-old attorney, tried to reduce his debt by transferring half of his student loan debt from his loan creditor to credit cards. Now, he owes $30,000 in credit card debt, and pays two to three times the minimum payment each month.

La Porte should not have put his loan on the credit card, Hobson said.

"Student loans usually have anywhere from a 6 to 8 percent interest rate, and you have a lot more flexibility in negotiating with student loan companies than credit card companies," Hobson said. "Once you put the loans on your regular credit cards, you've jumped back up to interest rates around 18 percent. So again, unless you know you can pay them off very quickly, don't do it."

LaPorte pointed out that many debt consolidation companies claim to be "non-profit," but Hobson says that term can be deceiving.

"Non-profit doesn't mean no-profit," Hobson said.

Sometime debt consolidation companies will take one month of payments as a service fee, set-up fee or processing fee. Money that you think is going to your credit card company is going to the credit counseling company, Hobson said.

In other instances, the debt consolidation agencies refer consumers to another company for a loan, since they do not offer loans themselves. They sometimes are associated with for-profit lenders, essentially passing on your business to their friends.

"Bottom line — this is a business to make money," Hobson said. "Ask yourself what are they doing for you that you couldn't do yourself with just a few phone calls."

Which Companies Are Legitimate?

Carlas Gilbert, 35, of Chicago, owes about $10,000 in credit card debt over five cards. She pays about $600 a month to try to whittle it down. She wanted to know how to know which debt consolidation companies are legitimate.

"You see all these ads for companies, so how do you know which ones are legitimate, and which aren't?" Gilbert asked. "How do you know the difference?"

Hobson says to be wary of companies that offer "simple solutions," and look out for danger signs, words like "easy," "painless," and "cannot be turned down."

Generally, the "good guys" belong to the National Foundation for Credit Counseling, which has more than 1,300 offices nationwide, Hobson said.

Founded in 1951, this organization imposes stringent accreditation guidelines and a certification process for credit counselors. Many NFCC-accredited agencies rely on the United Way or government grants for part of their funding. At these agencies — the largest of which is the Consumer Credit Counseling Service — consumers can meet with counselors face-to-face, arrange for long-term budget guidance and establish debt management plans, all for a nominal or no fee.

Many of the newer debt consolidation agencies that Hobson classifies as "not so good," conduct most of their business by phone or fax. These organizations rely heavily on advertising, particularly through the telephone, the Internet and infomercials.

Though they have attracted thousands of clients, they have also been subject to numerous complaints about their fees, often equivalent to one month's worth of payments. Many consumers are unaware that their first payment goes to the consolidator and not to their creditors. This confusion often results in late payments that can damage people's credit ratings.

Hobson said her biggest piece of advice for those who are digging out of debt is to cut up their credit cards, with the exception of one that can be used for emergencies.

Mellody Hobson, president of Ariel Capital Management in Chicago, is GoodMorning America's personal finance expert. Click here to visit her Web site, Ariel Mutual Funds.com. Ariel associate Matthew Yale contributed to this report.

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