Debt consolidation involves taking out one large debt to pay out several smaller debts, which would then be closed.
These smaller debts include credit card debts and short-term loans among others.
While it may seem like the ideal solution, it is not always the best not the cheapest option. We’re going to have a look at the hidden dangers of debt consolidation and ensure you know the downside before going ahead with it.
Unsecured loans can be consolidated
In terms of unsecured loans, you can expect to be able to consolidate several short-term loans and high-interest debts for example payday loans, credit card debt and overdue bills.
These debts would then be consolidated and rolled into one loan. You will benefit from a lower interest rate by repaying these unsecured personal loans and opting for a larger secured debt consolidation loan.
How debt consolidation can help you?
When you consolidate your debt this will free you from harassment from creditors. Your debt consolidation lender will also negotiate better rates and repayment terms with your creditors.
As soon as your debt consolidation loan has bee paid in full, which may take some time, you will have better credit and you will be allowed to take out credit cards and other loans once again.
Benefits & disadvantages of debt consolidation loans
- Interest fees cannot be avoided and this may not offer you large savings. The interest may be reduce overall but it will not always save you money overall.
- You can be debt-free within a set period. Even if you will be repaying the new loan for many years, you will have a clear picture of when you will be debt free.
- Repayments are not always reduced. They may reduce by a small margin, but the payment pressure remains the same even if the repayments have been reduced.
- Charges and fees. Debt consolidation usually come with fees and charges which are paid upfront or added in to the principal loan amount.
- Reduced interest rates are possible. The credit card debt may not necessarily be lower, but the interest rates would be and this will save you money.
- Can be difficult to get. A debt consolidation loan may be very difficult to obtain if you don’t have a good credit history and have already missed repayments.
Remember that there are always options available to you, so you do not have to drown in debt. Speak to your licensed financial adviser, they are always more than willing to help.
There are many online sites that you can also look at that will offer you many options to get out of debt. You don’t have to struggle alone.
The whole point of debt consolidation is to save money and simplify your debts by lowering your repayment amounts by bringing it all together in a single loan.
When taking out a secured debt consolidation loan, you are converting your unsecured debts into debt by your home or other property.
To lower your monthly payments, debt consolidation would be a wise option and it helps simplify your debts so you only have to be concerned with one monthly repayment.
It is however still important to understand the dangers of debt consolidation so that you don’t inadvertently make your financial situation worse.
To help you make an informed choice, here are some things to watch out for.
#1) Sinking deeper into debt
The biggest mistake that you can make is applying for a debt consolidation loan and placing yourself into more debt because you didn’t use it for its intended purpose.
So it would be important to deal with the reason you got into debt in the first place before applying for the debt consolidation loan so that you understand what it is for and you can then prevent any more overwhelming debt.
Always make sure that you have a plan in place so that you do not take out other loans or overspend when you receive the debt consolidation loan.
#2) Paying more in interest
The biggest benefit is being able to lower your interest rate and for a limited period you can enjoy the lower interest rates, but that does not mean your interest rate will definitely be lower.
With all your combined debts you may very well find yourself paying more overall in interest on your new loan that you would’ve with your old debts combined.
#3) Consolidation scams
Some lenders will put out misinformation for them to get to you and use your ignorance to their advantage and trap you into a consolidation loan that is not beneficial to you.
There are unfortunate instances where people find themselves in a predicament and then find out that many of the loans out there are not consumer-friendly and the interest charges may be very high.
Research as much as possible to avoid any debt consolidation scams. You need to know everything you can about interest rates and personal loans, terms and total loan cost.
Always research the lender themselves and see what people have to say about them. The Consumer Financial Protection Bureau has a helpful database as well. You can also take advantage of loan comparison sites to find trust worthy lenders and good offers.
#4) Putting your retirement & home at risk
There are different ways to consolidate debt, including personal loans and balance transfers. Both of which can be a great option in reducing your rates without taking on a lot of additional risks. Some borrowers take out loans to pay existing debt or they will borrow from their pension funds.
Doing any of these will be so risky, because if you do not pay your loan, then chances are you can lose everything that you worked so hard for. You will be hit with a penalty for any late payments and you could lose out on your retirement fund because of that.
Disadvantages of debt consolidation
- Prepayment penalties
Prepayment penalties are not as common as before but they remain factors in debt consolidation decisions. Where they are still being used, they can snuff out your chances of debt consolidation.
- Subprime borrowers may struggle to find affordable loans
Subprime loans are bad credit loans without collateral. Borrowers that are credit impaired will struggle to qualify for unsecured debt consolidation with suitable low monthly payments.
Secured debt consolidation
Debt consolidation is very tempting for someone that is new to it and that has little or knowledge of it. You must, therefore, make sure that your (APR) is very low. The best way to do this is to opt for a secured debt consolidation loan rather than an unsecured loan option, however, not everyone has equity in their home or collateral available.