Debt consolidation might be good for you If your financial ends have been apart for so long they wouldn’t recognize each other — even if you could get them to meet. However, like any other financial strategy, debt consolidation has its positives and negatives.
Here’s what you need to consider before you take this approach.
What Debt Consolidation Is and Is Not
In a nutshell, debt consolidation involves the taking of a loan large enough to encompass all of your debts and using that money to pay all of your creditors in full. This can be a good solution as it reduces the number of different monthly payments you make each month and ideally, you’ll see a better interest rate than you would on your credit card and other unsecured debt.
However, far from being a get-out-of-jail-free card, debt consolidation loans are typically secured by real estate or some other tangible asset. This means you’ll trade unsecured debt for secured debt. If things go sideways and you’ve put your home up as collateral, you could lose it.
Debt Consolidation Pros
One Monthly Payment: As we mentioned above, all of your credit card debt, medical bills, revolving credit accounts will be rolled into one loan. This gives you a single monthly payment to consider and potentially lowers your interest rate.
Lower Interest Rates: Credit cards can carry interest rates as high or higher than 20 percent. Further, if you’ve pushed those cards beyond their limits or have late payments on file, you could also be facing some high fees. In most cases, you can find consolidation loans at 10 percent interest, which would effectively cut the rate in half. This will save you a considerable amount of money and make the account easier to pay off.
Protect Your Credit Record:You’ll stay out in front of your debt with a consolidation loan. Further, you’ll eliminate the risk of overlooking one of your accounts one month and taking a hit because of a missed payment. Sometimes, a consolidation can mean the difference between satisfying a debt and filing for bankruptcy protection, which will show on your credit report for 10 years.
Debt Consolidation Cons
Potential Scams: There are more than a few predators circling the skies looking for unsuspecting people upon whom to swoop. Examine all consolidation offers carefully to be certain you understand the terms of the deal. If the jargon is too much, go see an accountant or a credit specialist and ask them to help you decipher it.
Look for peer validation like Freedom Debt Relief reviews provided by people who have worked successfully with the company you’re considering settling and merging debts. The last thing you want to do is make a bad situation worse by falling victim to a scam artist.
Potential for Increased Debt: It can be all too tempting to look at those credit accounts with zero balances and think it’s OK to charge just a little something. Thing is, in all too many cases, that little something morphs into yet another monthly bill. That’s when the purpose of the consolidation will be defeated.
This is compounded because closing those old accounts can have an adverse effect on your credit score. One element lenders consider is the length of your credit history. Closing old accounts makes your history look shorter, which will cost you credit score points.
You’ll also get a plethora of new offers in the mail when other lenders see your debt-to-income ratio has improved because of your balances being cut to zero. Don’t go for the okey-doke. Stop charging things after doing a consolidation. Put the money you save away for an emergency fund first — then use it to save to pay cash for any large purchases.
You Could Dig a Deeper Hole: Dovetailing into the scenario above, you could be in worse shape than when you started if anything pulls you off of the budget you need to maintain to repay the consolidation loan. If this happens, your credit history will take a hit. You’ll also be looking at stiff penalties. And, again — you could lose your house if it’s used to secure the loan.
Those are the primary pros and cons of consolidation loans. It’s crucial to give yourself some time to be certain you can meet their terms before implementing this strategy.