A debt consolidation loan combines many smaller debts with varying interest rates and payments into one loan with a single interest rate and set payment.
These loans are usually secured by a second mortgage on a home.
Credit card debt is the most common reason for debt consolidation loans. Credit cards have become a convenient way to finance purchases and very few people actually understand the Annual Percentage Rate, compounding interest and fee structures of credit cards. Most people feel if they can cover the monthly payment a credit card is quicker and easier than getting a loan for $400 flat screen TV.
Eventually consumers outspend their income and find themselves struggling to make the monthly payments on consumer credit. Credit cards often offer extremely low introductory rates for a period of time and then the interest rates jump very high at the end of the period. Most credit cards are variable interest rate, meaning the rate changes regularly and if you miss a payment, the credit companies can raise the interest rate more.
A debt consolidation loan is designed to pay off outstanding debt including, car loans, personal loans, credit cards, payday loans and any other debt. The purpose is to create one monthly payment that is structured and affordable. This type of loan is only valuable if the payment is less than what you are currently paying and the debt can be paid off faster. Also there is no point of getting a debt consolidation loan if you plan to use credit card again. Too many people are unable to break the habit of using credit cards and they continue to overspend.
Some things to consider when consolidating your debt:
- Check for early repayment penalties on any debt you intend to pay off
- If unable to finance all debt into one loan, pay off the most expensive debt first. This may not be the largest outstanding amount but the one with the highest rates. This is the smartest use of your loan funds to pay off the most expensive debt first.
You have to have enough equity in your home to qualify for debt consolidation. This means the value of your home has to be more than what you owe on your first mortgage. While you may have a loan amount lower than the value of your home, most moneylenders require sufficient value ratios in order to offer a second mortgage for debt consolidation, therefore you may be charged for an appraisal and other loan fees that need to be considered into the entire debt consolidation benefit or not.
The major risk of debt consolidation loans is the inability to curb your spending and using credit cards again.
This can put your home at risk if you are unable to make the payments of the consolidation loan.
Deciding if a debt consolidation loan is the right move for you will require sitting down and calculating the cost savings with loan fees included versus an optional plan to repay outstanding debt. Some lenders will lend without collateral on smaller amounts but most require collateral such as your home therefore you must consider all the benefits and drawbacks before getting the debt consolidation loan.