September 28, 2021

Debt Consolidation Loans: Using Them to Get Out of Debt

If you’re knee-deep in debt then it’s likely you’ve heard the advertisements for debt consolidation loans—those slick pitches that promise to solve all your financial problems, wipe away debt forever, so you can live happily ever after. Despite the fact that many people use debt consolidation loans as springboards to deeper debt, is it possible to gain some advantage if you’re aware of the pitfalls?

Types of Debt Consolidation Loans

A debt consolidation loan can come in various flavors. You might hear it called a home equity loan, a mortgage refinance loan, personal loan, consolidation loan, and might originate with a bank, a credit card company, or another type of financial lending company.

  • Home Equity Debt Consolidation Loan: Using your home as a vehicle for debt consolidation is risky. A home equity loan is a loan made against the value of what you’ve already paid on your home loan. And it’s understandably an attractive option. But your home literally becomes your collateral—the bank may seize it if you fail to make good on your debt.
  • Personal Consolidation Loan: Credit card companies and banks may offer personal consolidation loans. The terms of these types of consolidations is based on your credit rating, or your financial risk to the lender. High interest rates are a risk with these types of loans.

How a Consolidation Loan Works

How does a debt consolidation loan work? A lender pays off your loans and writes you a new loan. A common misconception is that a lender somehow rolls your debt or outstanding loans into one convenient and affordable loan. But it’s hardly that simple and can be an expensive option in the long run if you’re not careful.

Using a Debt Consolidation Loan to Get Out of Debt

How should you use a debt consolidation loan to help get out of debt?

  • Talk to a financial advisor before you consolidate anything. Your bank may have an in-house financial professional that you can talk to for free or for a low fee. And your bank may offer alternative solutions in cases of hardship.
  • If you have to resort to debt consolidation loan, explore your bank’s products first. Usually you’ll get better interest rates and certainly a more reputable lender than if you use a credit card company or other source.
  • Make a personal or family budget. It’s imperative that you face facts about your spending habits before you can fix the problem.
  • Downsize your bills and expenses wherever possible, avoiding credit cards at all costs.
  • Consider the debt consolidation loan a springboard to a better, healthier financial life. Pay more than the minimum monthly payments and certainly pay it off as soon as you can.

Common Pitfalls of Debt Consolidation Loans

Before you jump into a debt consolidation loan, make sure you avoid the common dangers:

  • Beware high interest rates
  • Monitor your credit rating and score
  • Know all the terms of the loan: interest rate, fees, the amount you borrowed and estimated final pay-off
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