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The American household debt load has reached an unprecedented level. As of the end of the first quarter of 2017, the household debt level reached a whopping $12.73 trillion. Surprisingly, this is $50 billion higher than the previous high recorded at the beginning of The Great Recession nearly a decade ago. According to the quarterly report of the Federal Reserve Bank of New York, and its Center for Microeconomic Data, low interest rates fueled by relaxed lending standards by banks and other lending institutions are driving household debt to new highs.
Rising household debt, while mostly comprised of home mortgages, is showing no signs of waning. Credit cards, student loans, and auto loans still make up a large number, although delinquencies are not nearly as high as they were in 2008. With consumer confidence on the rise, the stock market soaring, and the economy improving, consumers feel better than ever about taking on more and more debt.
Many consumers get themselves in over their head with debt. Most American consumers have no experience or education in managing their money or formulating an adequate budget. Overspending and irresponsibility often times lead to unnecessary debt that can jeopardize the financial health of the consumer. With Americans having very little savings, they are vulnerable when a financial disaster strikes such as a job loss or a medical emergency. When everyday unexpected expenses occur, such as the need for a new refrigerator or furnace, the majority of Americans turn to credit cards to get over the financial hump.
While mortgages are sometimes, “good debt,” if affordable and a good investment, credit card debt is never desirable. As credit card debt piles up, many consumers are blind to where this accumulation of debt is leading. If they do not act accordingly and timely, they could be facing very limited options when it comes to resolving their debt.
Therefore, many consumers look to consolidate their debt via a debt consolidation loan, either through a personal loan through a bank or finance company or a loan that utilizes the equity in their home.
Types of debt consolidation loans
Debt consolidation loans generally package all of a consumer’s debt into one loan with one payment. Generally, debt consolidation loans have a lower interest rate than what the consumer is currently paying on his or her credit card and other debt accounts.
Most consumers are hoping that by reducing the interest they pay, they can create additional cash flow that will help them better manage their day-to-day expenses and keep them from depending on credit cards just to get by. By discontinuing the use of credit cards, they hope to be able to pay off their debt.
When consumers seek debt consolidation, a couple of choices are of note. The right decision is dependent upon the individual circumstances, such as credit score and loan size, as well as whether the consumer has sufficient home equity.
Home equity lines of credit (HELOC) are a common source of funds to consolidate consumer debt. Quite simply, it is a line of credit, approved up to a certain amount, which the homeowner can borrow against when needed. They can also pay it back as they like as long as they pay the accrued interest on what they have borrowed each month. At some point, the lender may convert the loan to a fixed payment schedule.
The money drawn off a home equity line of credit is usable for any purpose at the discretion of the borrower. The low interest rates and minimal closing costs usually offered by banks and mortgage companies make these loans attractive. Employed homeowners who have a good amount of equity in their home and good credit scores will usually be able to gain approval for a HELOC.
Another type of mortgage loan that consumers can consider is a home refinance with cash out. Homeowners refinance their current mortgage, with a new interest rate and new terms, and borrow additional funds on top of their previous mortgage amount to use to pay off their other debts. Again, consumers should have a good credit score, a good amount of equity in their homes, and have gainful employment.
A third option that consumers can consider when attempting to consolidate their debts is a personal loan. Banks typically issue unsecured personal loans, meaning there is nothing put up as collateral against the loan, such as a mortgage note. Personal loans require very good credit and generally are not ideal for consumers who have a large amount of debt. Banks have traditionally instituted lending caps on personal loans, and, while interest rates are good, the terms are usually short. These loans are ideal for consumers who are looking to pay off their debt quickly.
Pros of a debt consolidation loan
Under the right circumstances, a debt consolidation loan can help a consumer get back on the right financial track. Review five advantages to consolidating your debts.
1. One payment
For many consumers, the biggest advantage of debt consolidation is simplifying their financial landscape. By reducing their payments into one monthly payment, many consumers feel they have a better path to becoming debt-free. In addition, only having one payment reduces the chances of missing a payment or making a payment late, which could damage your credit.
Additionally, only having to deal with one creditor makes life a bit simpler and reduces the stress associated with debt problems. Finally, having to write just one check can free up time better spent with family or on other important life events.
2. Lower payment overall
Most consumers look to create additional cash flow each month by reducing the amount of money required to service their existing debt. By obtaining a lower interest rate and a longer term, many times, the payments required on a monthly basis are much less than what the consumer is currently paying. With extra cash flow, consumers may be able to set aside money into a savings account that can help shield them from using credit cards in the event of an unexpected expense.
3. Better interest rate
If market conditions are favorable, there is a very good chance that a consumer can refinance his or her mortgage into a lower interest rate. In addition, the consumer will certainly be able to recast the credit card debt into a lower interest situation. All of this translates to lower payments and a quicker payoff, as more of each payment will go toward the principal balance.
Consumers who are looking to consolidate their debt should be very familiar with the interest rates they are currently paying on their consumer debts
4. Get caught up
Those consumers who are struggling to keep up with their payments or have fallen behind can get a fresh start through debt consolidation. Getting a break from the stress and confusion of making multiple payments to multiple creditors is sometimes enough to put them back on the road to good financial management. If a family is struggling every month and having a difficult time making ends meet, a debt consolidation loan can be a chance to start over with managing finances.
5. Avoid damage to your credit
For consumers who have been struggling for some time with their debt and have missed payments or paid their accounts late, they can avoid further damaging their credit by getting their debt consolidated. The quicker, the better, as missed and late payments can affect a consumer’s ability to qualify for a debt consolidation loan. A consumer’s credit score can recover quickly from a late payment here or there, but an established history of erratic payments can be extremely detrimental.
Cons of a debt consolidation loan
There are certainly some very good upsides to taking out a debt consolidation loan. However, some potential drawbacks exist that consumers should be aware of before they make the decision to take this important step.
1. High closing costs
Many mortgage-based debt consolidation solutions such as a home refinance with cash out can carry significant closing costs. These can often run into the thousands of dollars and can add significantly to the balance of your new loan. You have the option of paying these fees upfront, out of pocket, but chances are, if you are looking to consolidate your debts, you don’t have this kind of cash available.
2. You could end up running up more debt
If you are not determined to make the debt consolidation process work and get yourself completely out of credit card debt, there is a very good chance that you could end up racking up more debt on top of your refinanced, consolidated debt. This will only make your situation more critical. It’s important that you close your credit card accounts and change your spending habits to avoid putting yourself and your finances in an even worse situation
3. You pay more interest over the long term
Consumers who make the decision to tap into the equity in their home need to understand that there is a good chance they could actually pay more interest over the life of the loan. This is because mortgage notes usually have long terms, typically 30 years. Therefore, even though the interest rate is much lower than that of your credit cards, because you will be paying on your balance for a much longer term, you could actually pay more interest over the long haul.
4. You don’t learn the hard lessons
Those consumers who put in the hard work of paying off their debts through sacrifice and determination usually learn valuable lessons along the way. Their chances of falling back into debt are much lower than they are for those consumers who have swept their debt problem under the rug by rolling it into their home mortgage. Often, for these consumers, they find there is little difference in their lives after a debt consolidation loan. Excess cash generated by the debt consolidation process often gets lost in daily spending rather quickly.
5. You put valuable assets at risk
Consumers must understand that when they roll their credit card debt into their home mortgage, they put their home, their most valuable asset, at risk. If unable to make the payments on your now, larger mortgage, you could place your home in danger of foreclosure.
What are my other options?
Debt consolidation can be a good solution for some consumers who have good credit and have acted timely in getting their debt problem resolved. For others who have waited too long or have damaged their credit and are unable to qualify, there are other options available to them without filing for bankruptcy. Bankruptcy should always be a last resort solution, as the fallout and effects to your credit are severe and long-standing.
For those consumers who are dangerously close to insolvency, there are other options other than filing for bankruptcy. Working with a debt relief company such as National Debt Relief can help you settle your debts with your creditors and work out an overall strategy for getting yourself free of debt. The process is not easy or fast, but it is an effective tool for eliminating debt.
Getting out from under a burdensome debt problem is a difficult task no matter which path you take. However, acting quickly, when you realize you have a problem, will help you get your problem in hand more effectively. Explore your options today and get yourself ready to tackle your debt problem.
