3 Little Known Reasons To Stay Away From Debt Consolidation Loans
August 26, 2008
A debt consolidation loan is often said to be a good way to reduce your debt. The common theory is that you can lower your interest rate, particularly if you’re consolidating credit card debt, and wind up with a smaller payment. This theoretically lets you get the debt paid off faster, saving money in the process.
The facts are a little different however. There are several reasons why a debt consolidation loan is often not a good idea. Here are three of the most serious:
1. Consolidating Your Debt Doesn’t Fix The Real Problem
If you’ve got a lot of debt, the problem likely goes deeper than just the amount of interest or the size of your payments. Chances are that you have a habit of overspending, buying things on credit because you can’t afford to pay cash.
Consolidating that debt doesn’t actually address the real problem - the habit of buying things you can’t actually afford.
Statistics show that a large majority of people who use debt consolidation to pay off credit cards and other high-interest consumer debt don’t change their habits and wind up with even more debt because they wind up continuing to charge things on the credit cards that the consolidation loan paid off.
2. Lower Payments Don’t Always Equal Money Saved
One of the “gotchas” about debt consolidation is that the lower payment that you often wind up paying is not always going to save you money.
In a lot of cases, the payments are lower because you are refinancing existing debt over a longer period of time. This lowers your payment, but by the time you finish making those payments, the total amount you paid can be more.
This is very often the case if you are rolling lower interest loans, such as a personal bank loan or car loan, into the consolidation loan.
For example, if you are 18 months into a 48 month car loan when you refinance it through debt consolidation, you will likely end up paying more in the end. You will have already paid 18 months worth of interest on the original loan, plus you’ll be making payments for the full term of the consolidation loan.
If the consolidation loan is 60 months, or 5 years (and many are longer), you’ll end up paying interest on that same car for a total of 78 months instead of 48.
3. Consolidation Loans Can Put Your Home At Risk
Many debt consolidation loans are tied to your home equity. These loans are made to sound like a great way to use the equity you have in your home to pay off high-interest debt, but the catch that is rarely discussed is that tying the loan to your home means your home is at risk if you ever default on the loan.
If you have an outstanding balance on your credit card, that debt is almost always unsecured. That means that the lender can’t foreclose on your home or repossess your car to force repayment of the debt.
But if you have a home equity loan that you used to pay off debt and you default on it for some reason, now your home is at risk of foreclosure.
Debt consolidation loans are not always a bad choice, but there are more drawbacks than advantages. Make sure you research your choices thoroughly before choosing consolidation for debt reduction.
Comments
Got something to say?
Sponsors
