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Why A Debt Consolidation Loan May Not Be the Best Answer

debt consolidation loan

When you have a lot of debt, a debt consolidation loan may seem like an easy way to bring an end to your problems. A loan may make your monthly payments easier to manage but it can also result in problems you haven’t considered. Unless you also learn to change your spending habits, it won’t prevent you from accumulating debt again. Let’s talk about why a debt consolidation loan may not help you in the end.

What Is a Debt Consolidation Loan?

The primary way to obtain a debt consolidation loan is to apply for a loan through a bank or lender and use the lump sum to pay off your individual debts. Consolidation loans sound often sound appealing because you could end up with a lower monthly payment on the loan, and instead of juggling several bills a month, you need to pay only one. 

Risks of Debt Consolidation Loans

One of the biggest risks of consolidating debt is taking on new debt without addressing the underlying cause of your current debt problem. If you pay off credit cards but still have the option of using them, it’s easy to start the same cycle all over again if money gets tight and you haven’t accumulated an emergency fund. If you turn to credit cards again, you could run into a situation where you have high balances along with the payment on your debt consolidation loan.

It’s also not easy to qualify for a loan if you’re struggling with debt. When applying for a loan, typically lenders consider the following criteria:

  • Credit score
  • Income
  • Total loan amount requested
  • Debt to income ratio

It’s common for a creditor to require collateral in order to qualify or a debt consolidation loan. For many people struggling with debt, collateral may be difficult to come by. It’s especially risky to use your home as collateral through a home equity loan, according to the Federal Trade Commission. If you consolidate your debt but are unable to make the payments, the company that owns the home equity loan can foreclose on your home.

Debt Consolidation Loan Alternatives

A Debt Management plan (DMP) through a non-profit credit counseling agency can help you find debt relief and gain control of your finances without incurring more debt and without the risk of taking on a loan. A DMP is not a loan, although it can assist you in paying off your debt in full while saving money and simplifying the process.

Some of the benefits of a Debt Management Plan may include:

  • One affordable monthly payment
  • Waived late and over-the-limit fees
  • Lower interest rates
  • Pay off debt much faster than on your own paying minimum payments
  • Eliminating collection calls
  • Ongoing financial education and support

How To Stay Debt Free

Creating a household budget can help you change the way you approach spending and debt. Understanding how much money you bring in each month compared to how much money you spend on necessities is an essential part of getting your debt under control. Make sure you create a budget you and your family can agree to live on, with a goal of saving towards an emergency fund to ensure that you stay out of debt!

The CESI Team is committed to helping you reach your financial goals. If debt keeps you from living the life you dream of, contact us for a free debt analysis today and get started on the road to a brighter future!

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