September 30, 2020

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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Are Debt Consolidation Loans Right For You?

Debt is one of those things that does not seem like a big deal, and than the ext thing you know you are drowning under it. All of a sudden it does not seem like you job pays enough and you start looking for a part time job. On possible solution that has the potential to simplify your life are debt consolidation loans.

Many people make the mistake of assuming that when they consolidate their debts, they are making their debt load smaller. This is not strictly the case. While there are times when the debt consolidation company might be able to negotiate with your creditors to get a reduction of interest, you are still going to be required to pay off the principle and a majority of the interest.

One of the things that consolidating your debt does is make it so that instead of making multiple payments on multiple loans being made every single month, you will only have to worry about paying on large payment a month. This payment is than divided amongst your creditors. Once this is done, you and your financial adviser can discuss the possibility of a loan that will pay off the debt.

For many people, a loan that pays their entire consolidated debts load is the answer to all of their problems. Many creditors are happy to discuss a significant reduction in the amount of interest they are owed if they know that they will be getting paid off in a short period of time. Having the interest reduced makes a huge impact on the amount of money you need to borrow. You will still have to repay the loan, but at least you will not have to worry about creditors calling you at all hours of the day and night.

Even though you still are not free of debt, you have to repay the loan, you are not usually in as deep a debt as your were before you paid off your creditors. The reason for this is interest rates. The interest rate on your new loan should be considerably less then the interest rate you were paying before you consolidated and paid off your pre-existing debts.

Taking out a loan to pay off your pre-existing debts is not always a safe choice. Since you are already up to your ears in debt, you are on shaky ground with regards to approval. You are probably going to have to put up some sort of collateral. Usually this collateral is your home. Considering that the credit card companies can not touch your house this might not be the safest option.

It is in your best interest to pay off the loan as quickly as you possibly can. The best way to do this is by adding a little bit extra to each months payment. Even if all you can afford is an extra five dollars a month, it will add up. Also plan on making your monthly payment a minimum of a week in advance. The last thing you need is to have a few payments be late and for you to start amassing late fees.

You want to pay off your debt consolidation loans as quickly as you can. Even if you can only afford to spare $5 a month, you should add it to the monthly payment. All of these little bits of money add up and you will pay off the loan and be debt free sooner versus later.

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