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Bankrate's Debt Adviser: Avoid variable-rate debt consolidation loan

Friday March 31, 6:00 am ET

Steve Bucci

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 MMI for additional debt advice or to ask a
question of the Debt Adviser go to the "Ask the Experts" page to ask a debt
question.