Many consumers in an effort to escape every rising interest rates are searching for a way to lower their monthly payments while avoiding growing debt. One way to reduce your interest rate, resulting in
more of your payment going toward the principle debt, is by using a consolidation loan to pay off high interest accounts. This has been a popular and often successful method used to pay off debt in a shorter period of time, however consumers should use caution before considering this alternative. This is especially true today, when hundreds of debt consolidation companies have popped up in response to the growing number of people looking for help in reducing debt. Unfortunately the danger of debt consolidation is not reserved for those who use third party companies to manage their debt. There are pitfalls that come along with the do-it-yourself method as well. Here are a three things to consider before you use a debt consolidation loan to repay current debt.
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Unsecured vs secured debt- Credit cards make up the majority of high interest debt that most people begin to have trouble paying in tough economic times. Before the credit crisis, banks offered low interest or even zero interest balance transfer credit cards, allowing consumers to pay off high interest credit cards with a lucrative very low interest credit card. Don’t expect to see those offers in the current economic climate which may be a good thing as balance transfer credit cards have their own pitfalls. With this option off the table, the next best thing for consumers not making headway with their debt is a consolidation loan. These loans are often secured by your house. If you, for whatever reason, find yourself unable to pay off the new consolidation loan, the result may be the loss of your home. While the benefits are obvious, the biggest danger from consolidation loans is turning unsecured debt into secured debt.
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Beware of new debt- You want to get out of debt-right? Otherwise there would be no need for a consolidation loan in the first place. While that is a good strategy, many people find that their poor money management habits (that got the in debt in the first place) can lead to more debt once credit cards have been paid off with a consolidation loan. Another way to incur more debt through this type of loan is the fact that you may qualify for more money than needed to pay off your credit cards. If that is the case, some people take the extra money for other expenses or purchases finding themselves owing more money than before the consolidation.
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Lower interest vs lower payments- The point of consolidating debt is to pay lower interest on your current balance. If you are facing a financial hardship however you may be tempted to take on a loan that offers lower payments with the same or even higher interest rates. This may help you by making your monthly payments more affordable, however in the long run you will repay more money due to the extended repayment period. In this case you might be better off contacting your creditors to explain your financial circumstances and try to negotiate better terms. Once you get back on your feet you would then be able to allocate more money toward your balances.
Debt consolidation loans can help consumers reduce and eliminate debt. The key is understanding your own financial situation and the terms of the consolidation loan before committing to paying off old debt with new debt. If by consolidating your debt you risk losing your home, incurring more debt or paying more in the long run, you may want to consider other options for debt relief.
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July 26 2009
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