Consolidation loans are designed to help people pay off bills and pay down debt. A consolidation loan can make sense, but never as a first step in resolving debt problems. There are some inherent problems that must be dealt with before a consolidation loan is advisable.
If a person is consolidating an unsecured loan, this means that he or she is exchanging unsecured debt for secured debt. Although consolidation loans are usually simple interest loans (interest calculated on an annual basis), the interest is often less than the cumulated finance charges of the debts that are being consolidated. These debts are usually based on compounded interest (interest on the interest that accumulates daily).
In addition, most consolidation loans offer lower monthly payments spread out over a longer period of time.
A consolidation loan can be a smart idea, if the person consolidating does not borrow more than what is actually needed to pay the outstanding bills.
For those who already have discipline problems, borrowing more than what is needed could easily become just one more way to splurge. Therefore, if a consumer does decide to consolidate, it is imperative that he or she not take on any more debt.
What tends to happen to most people who obtain consolidation loans is that they no longer receive large monthly bills from retailers and credit card companies. They then begin to feel like they don’t owe as much money as they did before and have a tendency to stop worrying once the supposed solution has been found. Therefore, they start to use one or two credit cards, and before long they owe several hundred (or thousand) dollars in addition to their consolidation loan.
Resist the urge to splurge. Unless the problems that created the need for a consolidation loan (usually overspending) are corrected, one should not consider obtaining a consolidation loan. Otherwise, a year or so later all the little bills will be back again, and when they are combined with the consolidation loan, the situation will be worse than it was before the consolidation loan.
No one should consider a consolidation loan until they have been living for six months on a budget that controls spending. During that six months, you should eliminate as much debt as possible.
Allow no more debt, including bank and personal loans, and cut up your credit cards if you are unable to pay them off each month. Develop a realistic balanced budget that will allow every creditor to receive as much as possible. Retire the debt, beginning with the high interest debt first.If all of them are high interest, pay the one with the smallest balance first. Once the smallest is paid off, put all the money on the next, and so on.
Once the overspending has been brought under control, if there is still unmanageable debt, it may make sense to substitute one large loan with a reduced interest rate for several smaller ones at higher rates.
The most common method of consolidating is through home equity loans. At first glance, it does appear to make sense to consolidate higher interest debts into one lower interest rate loan (especially if a fixed rate is offered and not a floating rate), by using home equity as collateral. Beware, home equity loans may be one of the worst ideas ever pushed on the average family. It encourages them to put their homes in jeopardy and borrow to buy things that they can easily do without, such as cars, or to pay off things that were originally purchased through overspending.
In addition, one of the primary disadvantages of using a home as collateral for an equity or consolidation loan is that, if a borrower is not able to pay the total amount at the time of the demand, foreclosure proceedings can be implemented without further notice.
Consolidation loans can be beneficial at times. However, the key to success with a consolidation loan is discipline. Once someone has consolidated his or her debts, he or she must maintain the discipline it takes to stop spending with credit, If he or she cannot stop abusing credit, the result often is deeper debt than before.
Tags: budget, credit cards, debt consolidation loan, debt reduction, finance charges, interest, overspending
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