Legalities

Legalities, a weekly column that appears in the Help section of the Southern Illinoisan, is a free service of the Self Help Legal Center. You can visit the Southern Illinoisan website at: http://www.southernillinoisan.com

Q: I have a lot of debts - credit cards, car loans, finance companies, the local furniture store, to name a few. I received something in the mail about paying off all of these debts with a "home equity" loan that has lower interest and I can make one easy monthly payment. My neighbor says that I should be careful about converting "unsecured" loans to "secured" loans. If the interest rate or monthly payment is lower, I can't understand why I shouldn't take advantage of this opportunity. What should I do?

A: As any financial planner, loan officer, or lender understands, whether you should "consolidate," "restructure," or "re-finance" a loan or mortgage is not always as simple as whether the interest rate is lower than the present interest rate you are paying. Consequently, before you consolidate, restructure, or refinance your existing debts, you should ask yourself the following questions.

1. What are my short and long-term financial plans? If you can't afford to make your loan payments now and you can't afford to make the payment even if you take out the home equity loan, then it probably won't matter what you do. The only difference is what will happen when you eventually miss one or more payments. Consequently, if your short-term or long-term plan includes winning the lottery, then you probably don't need to be worried about taking out the home equity loan, especially when you think about what could happen if you miss a payment. Which brings us to question 2.
2. What can go wrong if I miss a payment on the home equity loan? Most people have a lot of "unsecured" debt. Unsecured debt means that if you miss a payment, you can be sued, but you won't immediately lose any of your personal property because you did not pledge it as "security" to get the loan. The most common example of unsecured debt is the typical credit card. If you miss a payment on your Discover card, they can sue you for the balance but they cannot immediately come to your home and take your TV. Secured debt, however, is debt that is secured by something you own, like your home or your car. If you miss a payment on a secured debt, you could and probably will lose the item that you pledged as security. Consequently, if you restructure all of your unsecured debt into a home equity loan (which uses your home as security) and you miss a payment, you run the risk of losing your home.
3. The interest rate may be lower, but is the monthly payment or the total amount paid lower as well? Getting lulled into refinancing because of a lower interest rate or a lower monthly payment is a common mistake made by even the most educated among us. Most of the time, a lower interest rate is a good thing. However, if the period of repayment is longer than your current loan, you actually may be paying more in the end. Similarly, if you are making a lower monthly payment, but the interest rate or the period of repayment is longer, you could be paying more than if you stayed at the higher monthly payment. If you can't afford your present monthly payment, however, this may be your only option.