Choosing the Best Way to Get Out of Debt

Credit is necessary to have and important to protect. If you are in debt, consider all your options before deciding whether to use a debt consolidation loan, a credit counseling service, or other method to help reduce it.

If you are ever up at 3 a.m. watching television, you’ve probably seen ads for debt consolidation loans. These advertisements target consumers who have allowed debt from multiple credit cards and other unsecured loans to reach levels where they cannot meet minimum monthly payments. But for most consumers, debt consolidation loans don’t make sense.

Debt consolidation loans promise one affordable lower monthly payment instead of many. In many cases, the interest rates on these loans are higher than those on a person’s existing loans. Worse, typical consumer debt consolidation loans allow interest rates to skyrocket if even one payment is missed. With some debt consolidation loans, application and other fees can drive up the cost.

Don’t confuse debt consolidation loans with reputable consumer services that help reduce your overall debt by negotiating with your creditors and combining your monthly payments to affordable levels, while still making significant reductions in debt principal each month. The National Foundation for Credit Counseling has a locator that can help you find an accredited agency near you.

Debt restructuring loans for business owners often make sense when owners have relied on personal credit to finance their business. Startups and other undercapitalized businesses often bootstrap their business financing with personal credit cards because of the difficulty in obtaining business credit directly. Business owners who borrow money via personal credit card should account for the personal debt they incur for business purposes on the company’s books. It should be shown as a liability on the company’s balance sheet until repaid. Customarily it is shown on the balance sheet as a loan from a shareholder, even though the shareholder used a personal credit card to incur the business debt.

At some point in a business’s life cycle, it will probably be able to obtain credit. Even nontraditional forms of financing, such as borrowing against a company’s accounts receivable using factoring, might make sense. Another option if a business has equipment or real estate assets with available equity is to refinance those business assets and use some of the loan proceeds to repay the business-owner part of the personal debt that was incurred for business purposes. Paying off the owner’s personal credit card loans will put him or her in a much better position to obtain future personal and business credit and will reduce some of the owner’s personal financial risk. The balance of the cash obtained in the loan would serve as permanent working capital, thus making it unlikely that the business owner would need to use personal credit cards to continue to finance the business.

Sam Thacker is a partner in Austin, Texas-based Business Finance Solutions.