Advantages and Disadvantages of Debt Consolidation
Debt consolidation allows you to pay down the principles of your lending obligations faster, and it offers you means to salvage fair to low credit scores in preparation for a major purchase, such as a new home.
After all, when you're knee deep in debt and your credit rating is less than ideal, home mortgage lenders will charge premium interest on the money they provide for you, after debt consolidation, however, you can apply with your newly salvaged credit and thus get lower term rates. This in turn will save you tens of thousands of dollars (potentially) over the term of your mortgage in reduced interest payments alone.
Debt consolidation also will benefit you psychologically. When you're putting out multiple “debt fires,” you must juggle a slate of interest rates, terms, and potentially even threats from creditors. When you have just one or two monthly bills to pay, you can budget easier, and you avoid wasting grueling hours calculating out the consequences of different interest rates. Furthermore, debt consolidation costs may be tax deductible, see your accountant about potential implications for moving your money around.
On the con side, however, debt consolidation can pave the way for continued poor spending habits. If you dump your hard won equity into a financial initiative to pay off your bills quickly, you may end up with a longer mortgage term (reduced lifetime savings) as well as a still as yet unbalanced budget.
Sometimes, debt is a good galvanizer -- indebted individuals must learn to budget and think for the long term. Thus, if you paper over poor habits with an easy debt consolidation loan, your financial mistakes might lead to even more dire consequences in the future.
In addition, debt consolidation doesn't always work as planned. If you get involved with a small lender who goes out of business or passes your loan along to a less than scrupulous third party, you could find yourself in legal and financial deep water. In addition, a debt consolidation initiative may not always lend to you at an ideal interest rate.
For instance, if you only have a few credit cards, it may make more sense to move all or most of your debt over to your lowest rate card than to go through the whole song and dance of taking out an independent debt consolidation agreement.
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Debt consolidation entails taking out one loan to pay off many others. This is often done to secure a lower interest rate, secure a fixed interest rate or for the convenience of servicing only one loan.
Debt consolidation can simply be from a number of unsecured loans into another unsecured loan, but more often it involves a secured loan against an asset that serves as collateral, most commonly a house. In this case, a mortgage is secured against the house. The collateralization of the loan allows a lower interest rate than without it, because by collateralizing, the asset owner agrees to allow the forced sale (foreclosure) of the asset to pay back the loan. The risk to the lender is reduced so the interest rate offered is lower.
Sometimes, debt consolidation companies can discount the amount of the loan. When the debtor is in danger of bankruptcy, the debt consolidator will buy the loan at a discount. A prudent debtor can shop around for consolidators who will pass along some of the savings. Consolidation can affect the ability of the debtor to discharge debts in bankruptcy, so the decision to consolidate must be weighed carefully.
Debt consolidation is often advisable in theory when someone is paying credit card debt. Credit cards can carry a much larger interest rate than even an unsecured loan from a bank. Debtors with property such as a home or car may get a lower rate through a secured loan using their property as collateral. Then the total interest and the total cash flow paid towards the debt is lower allowing the debt to be paid off sooner, incurring less interest.
Because of the theoretical advantage that debt consolidation offers a consumer that has high interest debt balances, companies can take advantage of that benefit of refinancing to charge very high fees in the debt consolidation loan. Sometimes these fees are near the state maximum for mortgage fees. In addition, some unscrupulous companies will knowingly wait until a client has backed themselves into a corner and must refinance in order to consolidate and pay off bills that they are behind on the payments.
If the client does not refinance they may lose their house, so they are willing to pay any allowable fee to complete the debt consolidation. In some cases the situation is that the client does not have enough time to shop for another lender with lower fees and may not even be fully aware of them. This practice is known as predatory lending. Certainly many, if not most, debt consolidation transactions do not involve predatory lending.[citation needed]
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