Consolidation Loan: The good, the bad and the ugly

Consolidation loans can be good, but only if you’re the right fit.  Let’s talk about the pro’s and con’s of a debt consolidation loan versus consolidating your debt.

A debt consolidation loan does not mean no debt, and it doesn’t always mean less debt.  Consolidation is one of those “buzz” words that you hear everyday, and some debt consolidation companies would have you think that a debt consolidation loan will “set you free”.

A consolidation loan is taking out a loan to pay off your existing creditors.  The assumption is that you have a number of outstanding credit card bills and other debts with high interest rates (i.e. 18%-22%), and with a consolidation loan, you pay off all your lenders with this money, and pay a much lower interest rate on this new loan (i.e. 9%).

Two things need to happen for a debt consolidation loan to be successful for you.  One, you must insure that your new APR (Annual Percentage Rate) with the loan is less than the total of your outstanding debt, and secondly, you must close off all of the accounts that you just paid off with the loan.  If you can do these things, a consolidation loan could be good for you.

Make sure the lender does not charge a large upfront fee that they don’t tell you about.  And also watch out if the lender tries to roll the fee into the loan payments in an attempt to hide it.

As mentioned above, you must ensure that you close out all of the accounts that you just paid off with the loan.  Otherwise, the tendency will be to start using the cards again because they have a zero balance.  Then you’ll have 2 debts.  One with 22% and the other with 9%, and you’ll be worse shape than before.  CLOSE THOSE ACCOUNTS.

Don’t sign a debt consolidation loan unless you know the following:

1)  the principal amount you are borrowing.

2)  what the APR will be.

3)  how many payments you will make.

4)  what the closing costs are, if any.

If these things are not spelled out clearly on the contract, or you don’t understand the contract, DON’T SIGN IT.  It will come back to haunt you later.  Also, don’t keep any of the cash that you got from the loan for yourself.  Just borrow what you need to pay off your debts.

Now lets look at the negative.  What you’re doing with a loan is converting unsecured debt into secured debt.  If you don’t change your spending habits you could be in a worse position than before.  Remember, now that you’ve paid off your credit cards, the credit card companies will be eager to renew your cards, with an even higher spending limit.

Quite often, the consolidation loan is a second mortgage which is secured by your home.  If you default on your monthly payments, you may lose your home.

So it is important that you get into a debt management program to help you avoid future credit problems and avoid potential bankruptcy.

A debt consolidation program is much different than a debt consolidation loan.   In general, with this kind of program, all existing creditors remain the same, except that either through your efforts or a debt consolidation company, interest rates are renegotiated, reduced or eliminated so that your monthly payments are far less.

If you work closely with your creditors, and once again, totally change your spending habits, you may be able to eliminate your debt in 3-5 years.

Both programs have their merits, and it depends which program best fits you.

About The Author

Paul Sauder is a successful freelance writer providing helpful tips and advice for consumers on personal loans, second mortgages and equity loans.  His many years of mortgage industry experience have helped others understand the business.

This article from "articles for free" is reprinted with permission.

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