Summary

Many Americans are falling deeper into debt and seeking relief through debt consolidation loans, cash-out mortgage refinancing, and retirement plan loans. While these strategies may appear to provide solutions, they often come with hidden risks and drawbacks, potentially leaving borrowers worse off than before.

Though consolidating high-interest debt with lower-rate loans can seem advantageous, it does not address the underlying causes of debt. Moreover, these loans may encourage further spending, leading to even more debt in the long run. Americans are now facing record levels of household debt, and the popularity of personal loans and cash-out mortgage refinancing reflects an urgent search for financial relief.

💰 Record Debt Levels Are Alarming

Debt among U.S. households is climbing to unprecedented levels, with a staggering $13.54 trillion in overall household debt by the end of 2018. This total includes mortgages, student loans, and credit card balances. Credit card debt is back to its 2008 peak, and delinquencies—those over 90 days past due—are increasing. Personal loans have surged as the fastest-growing type of debt, with one in ten Americans now holding one. Additionally, the total personal loan debt hit a record $291 billion in 2018.

Cash-out mortgage refinancing has regained popularity as well, with borrowers paying off their existing mortgages with larger ones, receiving the difference in cash. Freddie Mac reports that 83% of conventional refinance loans in late 2018 were cash-out refinances. Of those, 40% of borrowers used the extra funds to pay off other bills and debts.

Takeaways:

• U.S. households are accumulating debt at record levels.

• Personal loans and cash-out mortgage refinancing are being used more frequently for debt relief.

Key Terms

• Cash-out Mortgage Refinancing: A type of refinancing where homeowners replace their existing mortgage with a larger one and take out the difference in cash.

• Personal Loans: Unsecured loans that are commonly used to consolidate debt.

• Serious Delinquencies: Debt accounts that are 90 or more days overdue.

⚠️ Risks Outweigh the Rewards

While cash-out mortgage refinancing and other home equity borrowing options are often marketed as a solution for managing debt, the dangers may far outweigh the benefits. These loans can drain away equity, which could otherwise be used for future wealth-building or emergencies. The relief provided is often temporary, as many borrowers continue to accumulate debt. Additionally, converting unsecured debt into secured debt puts borrowers at risk of losing their homes if they cannot keep up with payments. Turning unsecured credit card debt into a mortgage-backed obligation can lead to foreclosure if default occurs.

Similarly, loans from retirement accounts, such as a 401(k), present hazards. Failure to repay can lead to penalties, taxes, and lost potential earnings. A study revealed that 86% of people who left their jobs with an outstanding 401(k) loan ultimately defaulted on the debt, which transformed the loan into an early withdrawal.

Takeaways:

• Home equity loans and cash-out refinancing can place borrowers at risk of losing their homes.

• Retirement plan loans can trigger penalties, taxes, and lost growth if not repaid.

Key Terms

• Home Equity Loan: A loan that allows homeowners to borrow against the equity in their home.

• 401(k) Loan: A loan taken from retirement savings, which must be repaid or it will count as a taxable withdrawal.

💡 Smarter Alternatives to Debt Relief

Debt relief does not always require taking on more loans. Financial literacy expert Barbara O’Neill suggests that borrowers first try cutting expenses and increasing income—possibly through a side job—to make extra payments and reduce debt faster. Diane Standaert of the Center for Responsible Lending recommends contacting credit card companies to inquire about hardship programs that may offer reduced payments.

For those deeply overwhelmed by their debt, nonprofit credit counselors associated with the National Foundation for Credit Counseling can create debt management plans, which help lower interest rates on credit card debt. In severe cases, consulting a bankruptcy attorney before skipping payments can provide important legal insights into options like bankruptcy protection.

Takeaways:

• Consider cutting expenses and increasing income to avoid further debt accumulation.

• Seek hardship programs from credit card companies for relief before opting for a loan.

Key Terms

• Hardship Program: A plan offered by creditors to temporarily reduce or suspend payments for borrowers facing financial difficulties.

• Debt Management Plan: A service provided by credit counseling agencies to negotiate lower interest rates and manage debt repayment.

Conclusion

While consolidating debt with lower-rate loans may seem like a good strategy, it comes with significant risks. Borrowers must be aware that such loans do not address the underlying issues of overspending or the habit of accumulating debt. Instead, it’s often wiser to seek alternatives such as cutting expenses, increasing income, and exploring hardship programs or credit counseling before turning to additional loans.