If you’re in over your head with credit card debt, you may be wondering if a debt consolidation loan is the right solution for you. Debt consolidation loans combine all your debt into one loan, generally with a lower interest rate. Sometimes, these types of loans are a good solution for consumers if they’re committed to getting out of debt. For those who haven’t altered the lifestyle factors that led to their credit card debt problem in the first place, or are in danger of accumulating more debt due to extenuating circumstances, a consolidation loan could actually make the situation much worse.
Addressing the reasons you ended up into credit card debt is important, not just for making a debt consolidation loan work for you but also for your long-term financial health. Many Americans have never learned the money management skills of budgeting and saving, so it’s not surprising that so many are in serious debt. Overspending and living above one’s means has become the norm among consumers and, with little to no savings, they lack the resources to handle a financial emergency such as an injury, an illness, or a costly car repair. The bottom line is that most American consumers are dependent upon credit cards to get by month to month.
As debt accumulates every month, most consumers don’t understand that at some point they’ll reach a point of insolvency. If they don’t do something to head off this financial crisis, they could be facing bankruptcy at some point.
A debt consolidation loan can help get you out from under an oppressive debt problem when approached in the right way. While there are advantages to debt consolidation loans, some drawbacks exist that every consumer should be aware of before taking this important step. In addition, there are different types of debt consolidation loans to consider.
The different types of debt consolidation loans
Debt consolidation loans come in several different forms. Sometimes, consumers can become confused over the different options and not make the ideal choice. If you’re confident that a debt consolidation loan is the right direction for you, it’s worth spending a bit of time to become educated on the differences between them.
The goal of a debt consolidation loan is to combine all your debt into one loan, with one payment and an interest rate that’s lower than what you’re currently paying on your credit cards. In addition, a debt consolidation loan can help you create better cash flow by reducing the amount of money you’re paying toward your debt each month and freeing up funds to help with everyday expenses. The goal is to become less dependent upon credit cards and start managing your money better so you don’t wind up buried in debt again.
Choosing the right debt consolidation loan is dependent upon your individual circumstances such as your credit score, the amount of debt you have, and whether you have home equity you could use to mitigate your debt.
If you own a home and owe less on it than it’s worth, you have equity. Depending on how much equity you have, you could potentially use that equity to pay off your debt. There are two ways to tap into the equity in your home. The first is through a home equity line of credit, or a HELOC. Banks will usually approve you for a home equity line of credit if you have the required equity in your home, a decent credit score, and verifiable income.
Banks extend a line of credit to you, and you can draw off that line whenever you want, up to the amount approved. You can also use the funds for whatever you like. Just be sure you don’t spend your equity on frivolous items instead of your debt. The bank will also let you pay back the loan at your own pace as long as you pay the minimum every month. After a period of years, the lender may convert the loan to a conventional loan with a fixed payment schedule.
The other type of loan that utilizes the equity in your home is a mortgage refinance with cash out option. This means you refinance your existing mortgage but borrow money over and above your current mortgage amount to pay off your debt. It’s a completely new loan with new loan terms. With luck, if the mortgage market is favorable, you may end up with a better interest rate than before. Depending on how long you’ve had your existing mortgage, by recasting the length of the mortgage, you may even end up with a smaller payment.
The last choice you have to consolidate your debt is a personal loan. Personal loans are unsecured loans, meaning the bank doesn’t require any collateral for the loan. Because the risk to the lender is higher, you must have very good credit to qualify. In addition, because lenders will usually have limits on how much they’ll lend on a personal loan, your debt problem needs to fit within those confines.
Be aware of some distinct advantages and disadvantages before choosing to consolidate your debt. Understanding all the important aspects of consolidating your debt will help you make the right decision for your circumstances.
Advantages of a debt consolidation loan
Utilized correctly, a debt consolidation loan can offer you some help in getting back on track with your finances, but it’s important to determine that the loan will offer you real benefits.
Going from many payments to one payment
Making many payments each month can be stressful, and the complexity can lead to missed payments, which can damage your credit. By consolidating your payments down to one payment each month, managing your finances gets a lot easier. This can help you have a more positive outlook on your financial future and help you find more time to spend with your family or doing things you enjoy.
A lower payment
Usually, by consolidating your debt, you can lower the amount of money you pay each month on your debt. With a lower interest rate and friendly terms, the payments on your new debt consolidation loan should be lower than what you’re currently paying on your credit card debt. The extra cash flow created can help you better make ends meet each month and possibly start a savings account. That way, you can become less dependent upon credit cards.
A better interest rate
If you do your homework and shop around, you should be able to get a better interest rate than what you’re currently paying on your mortgage, which will translate to paying much less interest on your credit card debt as well. If you opt for a personal loan, the interest rate should also be much less than what you’re paying currently on your credit cards. Whichever debt consolidation loan you choose, a lower interest rate will translate to lower payments and a timelier payoff.
It’s important that you have a thorough understanding of your debt and the interest rate you’re currently paying. This is the only way you can evaluate the interest rates offered to you for a debt consolidation loan. You have to do your due diligence to be sure you’re making the right decision.
Getting caught up on your bills
If you’ve been struggling to stay current on your payments, a debt consolidation can bring welcome relief from the stress and help you catch up. Struggling every month to make ends meet is a difficult way to live. Sometimes, just getting a new start can help you get on track.
Save your credit rating
If you have a considerable debt problem and have been barely making it month after month, it’s just a matter of time until you miss a payment. A debt consolidation loan can save you from damaging your credit. While one missed payment won’t ruin your credit, a pattern of missed payments can.
Disadvantages of a debt consolidation loan
While there are some good advantages to taking out a debt consolidation loan, some disadvantages exist that you should think about and consider before going forward with a loan.
Closing costs on your loan
If you’ve chosen a mortgage-based debt consolidation loan, you’ll pay closing costs on your loan, often thousands of dollars. In addition, if you choose to roll those costs into the balance of your loan, you could be adding a significant amount to what you owe on your home. You can pay these costs upfront, but that would mean laying out a large amount of cash that you likely don’t have.
Risk of running up more debt
If you haven’t made the necessary lifestyle changes to curb your spending and avoid accumulating more credit card debt, it’s likely that you could be making a bad decision by consolidating your debt. If you consolidate your debt and then run up more debt on top of it, you have just made your situation twice as bad.
Paying more interest over the life of your loan
Even though your new debt consolidation loan may have an interest rate that’s less than the rate you were paying on your credit cards, mortgage loans carry long loan terms. Therefore, it’s possible that you could end up paying more interest than if you just paid off your credit cards through hard work and dedication.
Not learning your lesson
When you put in the hard work and sacrifice to pay off your debt, you learn some valuable lessons. Those consumers who put their nose to the grindstone and pay off their debt on their own learn valuable lessons and aren’t likely to run up their credit card debt again. However, mitigating your debt through a debt consolidation loan could make it all too easy for you and increase your chances of accumulating debt again.
Putting your most valuable asset at risk
When you roll your credit card debt into your mortgage, you’ve now secured your debt with your most precious asset, your home. If there’s ever a time that you’re unable to make the new, probably higher payment on your mortgage, you could lose your home to foreclosure.
Are their other ways to handle my debt?
Consolidating your debt can be the right decision if you’ve addressed your situation in time and your credit is relatively undamaged. However, if you’ve waited too long and can no longer qualify for a debt consolidation loan, there are other options available to you other than filing for bankruptcy.
If you’re close to insolvency, meaning you’re on the edge on not being able to meet your monthly obligations, there are companies you can work with to help you with your debt problem. Debt relief companies such as National Debt Relief can help you settle your debts with your creditors once and for all. While resolving your debt through debt settlement is not an easy or fast process, it could very well be the ideal solution.
Having an oppressive debt problem is difficult; however, if you address your problem quickly, you have a better chance of solving it with better results. Don’t wait until your debt problem is spiraling out of control; act today and protect your financial future.