Commercials claim that credit consolidation will save you money, but whether a consolidation loan will be truly beneficial depends on your circumstances. Before you apply for a loan, learn when consolidation is appropriate and when it’s better to find an alternative.
The Ideal Debt Consolidation Scenario
Debt consolidation can be helpful to you if it gives you better loan terms and if you don’t take on any new risks to your financial stability. Here’s how that ideal situation works: You owe money, usually on credit cards, and you’re paying high interest rates. You have good credit and thus qualify for an unsecured personal loan with a lower rate. You take out this new loan and use the funds you receive to pay off your previous debts. Going forward, you make payments on the new loan you’ve taken out. It’s easier for you to keep track of payments for one loan than for multiple credit cards. More importantly, you’re paying a lower rate on the loan, so some of the money you would have spent on interest can go toward paying off the principal. That means you can pay off your debt sooner and you pay less than you would have if you hadn’t consolidated.
However, not every consumer qualifies for an unsecured personal loan with a good rate. If you don’t have access to this type of loan, credit consolidation could be risky for you.
When Debt Consolidation Is Risky
If you aren’t able to consolidate your debts with an unsecured personal loan, you might qualify for a secured loan like a home equity loan. With these loans, you stand to lose your house if you miss payments. These loans often have low rates because they’re less risky for banks; unfortunately, they’re more risky for you. Consolidating with a loan that uses your home as collateral means that you are now putting your home on the line. While you may think you’ll be able to make the payments based on your current income, an unexpected event like a job loss could leave you unable to pay in the future. This is a very serious downside to consolidating with a secured loan.
CNBC reports that another situation in which loan consolidation can be detrimental is when the consumer isn’t fully committed to getting out of debt. In this case, a consumer might start charging purchases to credit cards all over again after he consolidates. Then he’s deeper in debt because he has both credit cards and a consolidation loan to pay off.
If it looks like debt consolidation could be risky in your situation, bear in mind that you have other options for reducing the interest you pay and managing your debts. One choice is to negotiate with your creditors and ask for a better interest rate. Bankrate notes that another option is to see a non-profit credit counselor and to enter a debt management plan if it’s appropriate for you. This plan allows you to make a single monthly payment like a consolidation loan would. It may also offer you a lower interest rate or a longer repayment period to make your payments more affordable. And because a debt management plan doesn’t let you take on new credit card debt while you’re enrolled, it helps you break the cycle of borrowing.
Debt consolidation can be the right choice for people who have good credit and who won’t be tempted to continue borrowing. For others, it’s safer to negotiate with creditors, enroll in a debt management plan, or simply continue to pay off their existing loans.
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