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Cons of Debt Consolidation
Are you thinking of getting a debt consolidation loan? Wondering if debt consolidation is right for you? You still don't know the difference between home equity and your neighbor's cat? Before you sign on the dotted line, here are some answers to the question you should be asking.
What kind of debt consolidation loan is this?
Loans come in two types: Secured and Unsecured. An unsecured loan is like a credit card. If you're late on a payment, you haven't promised a creditor that they can come take something. Because there is nothing of yours that the lender can immediately get at and sell, unsecured loans generally have a higher interest rate than secured.
A secured loan is like a mortgage. If you don't pay, you've told the creditor that they can come and take something of yours. The down side of a secured loan is that it's easier for the debt consolidation lender to take that property you promised them.
Most likely, if you own a home, your debt consolidation loan will be either a home mortgage refinance loan or a home equity loan. A home equity debt consolidation loan normally has a higher interest rate than a first mortgage refinance debt consolidation loan. Before you get any form of debt consolidation loan, sit down with a good mortgage or debt calculator program.
If you're refinancing over thirty years, how much is that debt going to cost you? How long will it take you to pay off your debts at the current rate? What is the interest rate on the loan? So, some kind of mortgage-based debt consolidation loan sounds good. Just remember you will be paying it off over a period of years.
Be careful not to borrow more than you need for your debt consolidation loan. Keep the repayment amount within your budget. But, don't obsess over what may happen if you're late on one mortgage payment. Contrary to urban myth, if you miss one mortgage payment, most mortgage lenders will not immediately foreclose. Even in states where foreclosure is, relatively, easy, it is still a costly process. In most instances, it leaves the creditor holding real estate instead of cash. They prefer cash.
Many adjustable rate debt consolidation loans are fixed to benchmarks that are notoriously high, such as the LIBOR average. If you have an adjustable rate mortgage, how much will you pay if the rate goes up to whatever it is capped? Plan your finances according to this. Plan. Ask. Plan.
If a debt consolidation loan looks like a good idea ask yourself, "Will I go out and borrow this money back?" Consolidating your debts, only to run up more on a credit card, leaves you with more debt in the end. If you are going to get a debt consolidation loan, are you willing to cut up your credit cards on the day of closing? If you're going to cut up both your credit and debit cards (a generally good idea), remember this means that you'll be paying for gas in cash. Will inconvenience cause you to apply for more credit in six months or a year?
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