Pros and Cons of Debt Consolidation

One of the popular terms in today’s climate of debt and financial stress is debt consolidation. Before we take any action when it comes to our finances, we need to make sure we understand precisely what it is we are considering. So if you are interested in the strategy of consolidating your debt and payments, read on.

What is Debt Consolidation?
Debt consolidation involves taking out a single loan in order to pay off several others. The objective of debt consolidation could be to get a lower interest rate, to secure a fixed interest rate or to make life simpler by having only one loan to deal with.

Debt consolidation can transform multiple unsecured loans into one unsecured loan. However, it more often involves taking out a secured loan against a valuable asset that acts as collateral. This collateral, or asset, is usually a house. So if you decide to use your house as collateral in your debt consolidation, you are basically taking out another mortgage. Because this mortgage uses the house as a guarantee for the loan, the lender can provide a significantly reduced interest rate.

Different Strategies
If you don’t want to go the route described above, you might decide to use a debt consolidation company. If you do this, sometimes the company can reduce the amount of the loan.

Debt consolidation companies can reduce the amount of your loan, or debt, by purchasing the loan at a discount from the lender. If you are nearing bankruptcy or some other severe financial crisis, this can be of great and immediate assistance. If you take the time to do some footwork, you can find a capable debt consolidator who will purchase your loan and pass on some immediate savings to you.

However, there is one important caveat. If you go into bankruptcy, doing debt consolidation can make it difficult for you pay off your debts, for legal reasons. So don’t just jump right into debt consolidation, no matter how great it sounds.

By now you should have a good idea of how debt consolidation can help you out. To summarize the advantages of debt consolidation:
* If you have a lot of credit card debt, on a variety of cards, debt consolidation can bring your balance and interest rate down.
* Debt consolidation also simplifies things when you have multiple debts that you are paying down. You end up with one payment.
* With interest rates lowered, you can actually get out of debt faster, which is really why we’re interested in this issue, isn’t it?

What to Watch For
By now you should be wondering how the debt consolidation companies out there make their money. Take a moment and think about it they make their money off of fees. In fact, something to watch for in these companies is high fees.

In fact, some of these companies, who are essentially mortgage lenders, charge loan fees that are near the state maximum for mortgage fees. Additionally, companies that are more out to make a buck than to help will often bide their time until a client has put himself between a rock and a hard place. At this point, the unscrupulous company then says the client must refinance in order to get out of their tough spot. Then the company can charge massive fees because the client is in a position that they might lose their home if they don’t do a debt consolidation.

This practice is what is known as predatory lending.’ Your best defense against this kind of unscrupulous practice is to shop around to different companies in order to find one that had lower fees and a track record of helping people.

Important Things to Keep in Mind
The current economic crisis has created a tempting situation for many people who are living with a heavy debt burden. Interest rates are lower than they have been in decades, meaning that debt consolidation through a refinance looks like a quick fix.

This reasoning is valid, but you need to make sure you do your homework. Don’t just leap into a deal because it sounds good. Take time to consider and shop around.

One of the quick fixes that many people are leaping to take advantage of is the strategy of using a line of credit to pay off high-interest rate credit cards faster. However, statistics show that of those who use this strategy, seventy percent end up with either the same or more debt load inside of two years.

The same thing has been shown to be true of those who refinance in order to consolidate debts. This is because the debtor, or the person who owes money, hasn’t made a change in their spending behavior. They have depended on more borrowing to help them with their previous debt.

Does that sound familiar? Borrowing money to fix your problems is like trying to fight fire with fire. It can be done, but if this is your only approach, you will not solve your long-term debt problems.

We’re not saying that debt consolidation is not a good strategy. In fact, it is a great way to kick start your debt pay-off. But this strategy should be only one of several tools that you use in order to reduce your debt completely. Other strategies you will need to implement include disciplining your spending with a budget, improving your credit score, negotiating interest rates and so on.

Your best bet is to find a robust debt-elimination program that has a proven track record and uses solid money management principles. Then you need to commit to that program and make measurable goals regarding your debt elimination.

Now that’s a recipe for success.