Are you dealing with a mountain of debt and looking for solutions to manage it? You may have heard of debt consolidation loans. Ads for these can be found on TV, magazines and even online. They promise to you get out of debt and on the way to a fresh start. They also give the assurance you’ll pay off your debt sooner and save money. The ads are tempting – they tell you all about the advantages of debt consolidation loans, but there’s another side to debt consolidation loan you should be aware of.
The companies who offer these services rarely discuss all the disadvantages of getting a consolidated loan. The truth is that over the long term, a consolidated loan could end up costing you more money and putting you more deeply in debt.
Before you agree to a debt consolidation loan, first consider all the pros and cons of such an arrangement. We’ve done the research and come up with a few things you should keep in mind before taking out a consolidation loan.
What is a Debt Consolidation Loan?
A debt consolidation loan is a loan that helps to refinance your debts – you take out one loan to pay off all of your debts. These types of loans usually cover personal finance debts such as credit card debt, student loans, etc. (unsecured debt). Multiple debts are combined into a single, larger debt that usually has a lower monthly payment and lower interest rates.
Debt consolidation loans come in different varieties and may be offered by:
- Debt consolidation companies that specialise in debt consolidation
- Balance transfer credit cards
- Financial institutions such as banks, etc.
Advantages of Debt Consolidation Loans
There are plenty of advantages that come with a debt consolidation loan. The major pros are stress reduction; you’ll not have numerous bills to pay each month. Instead you’ll only have one payment to manage. A consolidation loan also gives you a definite deadline for paying off your debt. In addition, you’ll find these advantages:
Lower interest rates
You pay higher interest rates when you have multiple debts on credit cards and other expenses. You could possibly be paying thousands of dollars a month just in interest, without even lowering your debt, usually when only paying the minimum balance due. With a consolidation loan, all of your debt is rolled into one, and you’ll usually have a lower interest rate, too. This means you’ll be able to pay off more of your debt in a shorter time, rather than just making the minimum payments that go mostly to the high interest you’re already paying. You can potentially save a lot of money with a consolidation loan.
Lower monthly payments
You could be facing high payments on each of your debts—including credit cards. Looking for a way to lower the monthly payment will help you quite a bit. A consolidation loan usually has a lower monthly payment than all your debts added together. Again, you have the potential to save money by using a consolidation loan.
Manage one monthly payment
You’ll only have to manage one monthly payment, rather than multiple payments. You’ll have one due date, rather than several. This makes tracking and paying off your debt easier and faster, if you stay organized.
Debt Consolidation Disadvantages
As with everything, while there are certain advantages to debt consolidation loans, there are also some negatives you’ll need to take into consideration. Let’s take a look at some of the disadvantages of a consolidation loan:
Lower your credit score
Taking on a debt consolidation loan could possibly lower your credit score. Some debt consolidation companies say they’ll help you settle your debt—they act as debt negotiators. You then pay them a specified sum each month, which some companies hold intentionally. This causes your payments to be late, giving the debt negotiator a way to lower the debt settlement so you don’t have to pay as much. This process can wreak havoc on your credit score. In addition, credit scores favour long-term debts with long payment histories. By getting a debt consolidation loan your credit history becomes shorter; lenders will see this as a new debt and see you as a risky investment.
You could lose important assets
For example, if you use a home equity loan to consolidate your debt, you could put your home in jeopardy. If you miss payments, then bank can come and repossess your home. You have to take this into consideration when seeking a consolidation loan.
May spend more over the long-term
While your interest rate will probably be lower, you could face a longer payback period for your new consolidated debt. You could also face higher interest rates. You can solve this problem by reading all the fine print on documents you may have to sign, staying organized, making your payment each month on time and paying off the debt as soon as possible.
High potential to increase your deb
With lower monthly payments, you’ll probably have some “leftover” money at the end of each month. Some people use this extra money to pay off their debt faster, by applying it to the debt consolidation loan. However, others choose to use their extra money to spend, sometimes spending over their limit. In this case, you could end up with even more debt than you had before.
Debt consolidation doesn’t get you out of debt
It helps to solve your monthly financial problems by replacing multiple payments with one; however, it doesn’t cure your debt problem. How did you get into debt in the first place? Was it overspending? Do you need to increase your monthly income? Did you have a big, unexpected expense? These issues can be fixed, but you need to take responsibility for your financial health first. Look at what got you into debt, then look for solutions and make a plan to get out of debt and stay out. Otherwise, you could be facing this problem over and over again for years to come.
As you can see, there are some major advantages and disadvantages to taking out a debt consolidation loan. Be sure to do your homework and get all the information you can about how debt consolidation could help or harm your financial bottom line. It’s a good idea to find a good financial advisor to help you decide if this is the best way to handle your debts.