Many of us have heard of debt consolidation loans. Some of you might have even used one before. They’ve gotten a bit of a bad rap over the last few years because they get associated with debt consolidation companies, some of which can be a bit shady. But, they aren’t all bad. And, in some cases, they can be a very useful tool in your debt repayment strategy.
Debt Consolidation Loans: What Are They?
The concept is actually pretty easy to grasp. As the name implies, a debt consolidation loan is a loan that consolidates all of your other debt and puts it all under one single loan. Depending on the lender, you can consolidate just about any debt. We’ll talk about some of the things you might not want to consolidate in later. For many, the prospect of trading their high interest credit card debt for a lower interest rate loan can be very enticing.
Debt Consolidation Loans: When Should They Be Used?
While you can get a consolidation loan at any time, there are a few times when they are of the most use. The most common of these is when you have several credit cards that have high balances and higher interest rates. As we all know, paying only minimum payments won’t get us very far, but having several cards to pay sometimes leaves us with little left over to pay extra towards those balances. A consolidation loan can reduce the interest rate, and reduce the payment amount, making it easier to pay extra on the balance. One of the biggest factors to determining if you should use a consolidation loan is your resolve to stay off the debt treadmill. If you can’t commit to not adding any more debt, you’ll only find yourself worse off in the long run.
Debt Consolidation Loans: Why Should They Be Used?
A debt consolidation loan can be a great tool when you’re working on paying off your debt. The reduction in interest rates and payments can help ease the burden of your debt while also enabling you to pay off the debt at a quicker rate. Again, if you aren’t committed to not adding any more debt, and you start using those same credit cards again, you’ll find yourself in a much worse situation than you were before. Combined with a commitment to no more debt, they are a great tool.
Debt Consolidation Loans: Caveats
With anything, there are a few things that you’ll need to watch out for. Besides reloading your credit cards, that is. Some lenders will attempt to roll a car loan or a home equity loan into the consolidation loan. Only do that if there is no other option. Why? Both the car loan and the home equity loan are what are called secured loans. There is some physical asset that the lender holds title to should you default. If you roll either into the consolidation loan, you don’t own that physical asset until the consolidation loan is paid off. Consider this example. You have a car loan for $5000, on a car that has a value of $10000. You roll that car loan into your consolidation loan along with $20000 in credit card debt. The total for your consolidation loan is then $25000. Until you pay that $25000 off, the lender will keep it’s lien on the car. What if you get in a wreck and total the car? You can’t use it as a trade-in, or sell it to a salvage yard until that $25000 is paid off and you can get the lien removed from the car. It’s a hairy situation to be in, to be sure. All that said, getting an unsecured loan can sometimes be difficult, and depending on your situation, some lenders might require at least part of the loan be secured. You’ll have to determine if that’s a risk you want to take in order to take ownership of your finances.
Much like any other financial tool, a debt consolidation loan can be helpful under the right circumstances. Be careful, examine the details, and learn how it works, and you can make sure that it remains that way.