What Is Debt Consolidation Really Going To Cost?
Consolidation is one of the most talked-about ways of dealing with debt. You'll see offers from lending companies, credit cards and even your bank, suggesting you take out a loan to pay off all your existing debts, combining them into a single payment with a lower interest rate in some cases. But the question is, is this a good idea? It sounds like it, but what is debt consolidation really going to cost you?
There are several things you need to consider before signing up for any kind of debt consolidation loan.
Are You Really Going to Be Saving Money?
If you are consolidating credit card debt, chances are you'll be paying a lower interest rate on your consolidation loan than you are on the credit cards themselves.
But a lot of consolidation loans require you to combine all your debt - not just credit cards - so you might have to include other loans which may have lower interest rates.
If this is the case, you need to determine whether or not what you save on the credit card debt is going to be lost on the rest of the loans you're consolidating.
How Long Will You Be Paying?
When you take out a consolidation loan, you're going to be starting from square one and will have that loan for whatever term you sign up for.
Again, if you're combining existing loans into the consolidation, you could end up paying them off for a lot longer than is left on the original loans.
For example, if you have a loan that has 12 months left before it's paid off and you consolidate it along with the rest of your debt, using a 48 month consolidation loan, you're going to be paying interest on that debt for an extra 36 months.
Even if the interest rate is lower, you'll likely wind up paying more interest in the long run.
What Are You Putting At Risk?
This is one of the biggest problems with most debt consolidation programs - what you're putting at risk.
Credit card debt and other consumer debt is generally unsecured. That means that there is nothing "backing" the loan for the creditor to repossess if you don't pay the debt.
This is the opposite of secured debt, which is usually things like your mortgage or your car loan. If you stop paying, the lender can foreclose on your home or repossess your car to recover their money.
When you take out a consolidation loan, they are often secured by some kind of collateral, most often home equity. These home equity lines of credit (HELOC) are essentially another mortgage on your home. If you can't pay, they can foreclose on your home.
By doing this, you're essentially taking unsecured debt and converting it to secured, putting your home at risk. If you ever lose your job or suddenly can't pay the debt for some reason, your home will be on the line.
Debt consolidation can work for some people, but in most
cases there are more risks involved than there are advantages.