What is Debt Consolidation?

Debt Consolidation is typically defined as taking your multiple high-interest loans and consolidating them into one, low-interest, convenient monthly payment. It is a quick, easy fix to get out of debt and lower your monthly payments at the same time so that you can use your money for better things, right? Read on... there are some things that the lenders don’t tell you about their loans.

There are two types of Debt Consolidation loans, Home-equity lending (also referred to as a secured loan), and Personal lending (unsecured loan).

Home Equity loans are given to consumers to consolidate their debts. You get one monthly payment with, usually, a pretty good interest rate: between 9 – 12%. This may be a good option for someone who recently took a cut in pay, divorced, unemployed, or just overspent their income and the debt repayment became too great. However, the downside to this is that you are putting your house up as collateral—if you fail to pay this loan you may find yourself out of the streets.

Personal Lending loans typically have a higher interest rate, 12 – 15%, but are not secured with collateral. The bank is taking a greater chance that you will repay the money borrowed so the fees (interest) are higher.

Who needs Debt Consolidation?

Debt Consolidation should only be considered as an alternative to bankruptcy. If you are already behind on your payments, receiving calls from collection agencies or attorneys, or are struggling to pay your bills every month then you may be a candidate for a Debt Consolidation loan.

Who doesn’t need Debt Consolidation?

Debt Consolidation should not be considered as a quick-fix to get out of paying your debts. Yes, the lower monthly payment may sound attractive and I’m sure the selling agent will be very convincing in telling you how much you deserve the extra money every month and how much fun you can have spending it. The truth is, however, a Debt Consolidation may end up costing you more then if you just paid your debt off yourself.

What to watch out for!

As mentioned before, you could end up paying out more to your Debt Consolidation loan in the long run.

Here are just a few things to watch out for:

Payments that are too low—Loan companies entice people with lower payments, but this may only stretch out your debt further, which, with the extra time in interest, may end up being a lot more then what you would have paid originally:

For example, you have three debts totaling $12,000, with an average interest rate of 18% and are making the minimum monthly payments of $240. It would take you 8 years and 4 months (100 months) to pay of this debt and you would pay out a total of $24,000!

On a Debt Consolidation loan however, that same $12,000 loan, if you were paying only $180 a month at 15% would take you just over 12 years to pay off the total of $26,100!

Yes, you save a little bit each month will be in debt much longer and will pay over $2000 more with their ‘money saving’ program!

The interest rate of the loan—as we mentioned above, make sure that you are aware of the interest rate of your new loan. Also, read the contract carefully to ensure that your interest rate is not an ‘introductory rate’ and that it will never increase during the life of your loan.

Expensive loan add-ons—Be careful if your loan company tries to talk you into additional ‘services’ such as insurance for sickness, unemployment, and death. These extra benefits may sound like a great idea, and I’m sure the loan officer will make it sound very attractive, but these extra fees may end up costing you tremendously. Loan insurance is sold so that, in the case of unemployment, sickness or injury that prevents you from working for extended periods of time the loan payments will be made for you until you recover or are able to go back to work. In the event of death, the loan will be paid in full so that the surviving spouse isn’t stuck with the bill.

Again, this may sound great but most people never use the insurance, and, at an extra $25 - $50 a month, you would be better off putting this money into an interest bearing savings account should an emergency arise down the road.

Is this a secured loan or unsecured loan?—Is it possible that you could lose your home if you miss a payment or two? Putting your home in jeopardy is not worth the risk. If you can’t make your payments now chances are you will be in trouble again down the road and this time it could leave you homeless. If your debt is so great bankruptcy may be a better alternative as usually you are able to exclude your home.

Shop around for a reputable company with low fees and better rates—Doing a little bit of homework could greatly pay off. Shop around and look into a few different agencies and look for the best rates and terms. Make sure you do that math and see the bottom line!

A few questions to ask:

Are there any sign-up fees?

What is the interest rate?

What is the monthly payment?

What is the length and terms on the loan?

Can I pay extra on the loan without any penalties?

What is going to be my total payout during the life of the loan?

A lot of times Credit Unions typically offer the best rates. If you have one available make sure you include them in your search.

How can Debt Consolidation help?

Even though we may sound a bit negative when it comes to getting a Debt Consolidation loan there are some benefits and we don’t mean to discourage anyone who is looking into this form of debt repayment.

Some of the benefits include:

• Making one monthly payment instead of several—Tired of writing out a dozen checks every month and keeping track of the different balances and interest rates? It is much simpler only having one creditor to deal with. Just make sure that you don’t incur new debt now that you have a lower payment!
• Lower interest rate—You will probably be able to get a lower interest rate then you are currently paying. Usually, a lower interest rate means less money in the long run.
• Lower monthly payment—If you are having a tough time paying your current debts because the interest rates and payments are too high then Debt Consolidation may be the right solution for you. Not only does paying back your debts make you feel good it is also biblical (Psalm 37:21)! Debt Consolidation can save you anywhere from a few dollars to a few hundred and may just provide the relief that you need to get back on track.

How can Debt Consolidation hurt?

Debt Consolidation is often glamorized and a quick and easy way of getting out from under your debt so that you can get on with your life. You are special, you deserve it! The facts are, however, that Debt Consolidation is not for everyone and should only be considered by those who truly need the help.

Debt Consolidation loans may hurt your credit—By getting new loans and closing out the old you are actively using your credit and your report will reflect that with a lower FICO score. Typically the loan benefits may outweigh the drop in your credit score in the long run, but should be avoided if you are capable to do so.

Getting further into debt—Without proper training and guidance to discipline the consumer, the same root problem still exists: overspending and poor money management. If you are debt you may want to seek help with learning how to budget properly, curb your spending habits, and, most importantly, cut up those credit cards or store them away in a safe place for emergencies (note: a new pair of shoes or a bowling ball does not constitute an emergency). Without proper spending habits and discipline, you may be in danger of running up more debt now that you have a lower monthly payment. Don’t do it!

Visit the other pages on our site where we give advice and tips on developing (and sticking to) a budget, how to balance your checkbook, and money saving techniques and tricks.

Debt Consolidation Alternatives

Negotiating with your creditors on your own—If you are not too far behind on your payments you may be able to call your creditors on your own and ask for a lower interest rate. Many credit card companies would rather take a cut in their interest as an alternative to you filing bankruptcy. Explain the situation to them, let them know that you want to pay off your debts and see if they would be willing to help, but don’t threaten!

Bankruptcy, Credit Counseling, & Debt Settlement—We’ve also written articles about these alternative forms of debt repayment. You may want to look into each of these to see which one is right for you and your current situation.