Debt consolidation is a type of debt refinancing which involves taking out a single loan to repay several others. This commonly refers to an individual finance strategy of people dealing with high consumer debt; however, sometimes it can also refer to the overall financial system dealing with heavy debt, such as that of Greece. The term debt consolidation is usually used in association with mortgage debt consolidation since these loans can be renewed. The two concepts are very similar and are often used interchangeably, but debt consolidation does involve taking out another loan to clear debts already outstanding. The fact that the refinance of the home mortgage is also a debt consolidation decision makes it even more relevant to those looking to take advantage of this solution.
However, this may not always be the case, and when it is not a viable solution for some, it can have disadvantages. Indeed, some debt consolidation advantages are also disadvantages, depending on individual situations and needs. In addition, certain factors should be considered to ensure that debt consolidation is the right option for your situation.
One of the debt consolidation advantages that has some significant disadvantages is that it may lead to increased borrowing. That is especially true for those whose credit card consolidation plan includes a new loan. While this sounds like an excellent idea initially, the fact is that most credit card consolidation plans come with exceedingly low interest rates, and thus borrowers are tempted to begin spending again, using the new loan. Eventually, however, even if the new loan has lower interest rates than the original, that the new loan will have to be repaid, and this will inevitably lead to higher monthly payments that have yet to be reduced by the increased interest rate.
Another disadvantage is that debt consolidation can affect your credit score, in the same way that late or missed payments do. Depending on how badly damaged your credit score is, you could find that it takes years for it to recover. In addition, if you have already paid debts through debt relief or other means, you may find that your credit report doesn’t accurately reflect your current level of indebtedness. This is because, while all your past debts are listed, only those that are currently due are shown, so if you haven’t been paying them, they’ll still be there. When you consider the impact of missing or late payments, this can add up quickly.
Another disadvantage is that debt consolidation often involves taking on another loan, which carries its own risks. Typically, a debt consolidation loan is secured with your home or other valuable property, and since your credit score is already lowered by having several outstanding loans, you may find that the new loan is difficult to obtain. In addition, if your credit score is already low and you take out yet another loan, it is likely that you will end up with a higher monthly payment, and, again, your credit score will be affected negatively.
If you choose not to use a secured debt consolidation loan, another option is to opt for an unsecured loan. While this will keep your assets secure, the downside is that you won’t be able to make the high-interest payments typically made with secured loans. Unsecured debt consolidation loans are available, however, and they are designed for borrowers who don’t want to entrust their homes or other property in the hands of creditors. In order to obtain one, you’ll be required to provide collateral, which should be something such as a vehicle or an income producing business. As with secured loans, you will likely have a much higher interest rate and a shorter repayment period.
The final type of debt consolidation, you may hear about is debt management. Debt management companies offer a variety of services that include budgeting, debt counseling, and settlement of debts. These companies also work with creditors, often resulting in lower interest rates and payment plans that allow you to pay off your debt more quickly. Like a personal loan, debt management companies can offer a variety of payment options but usually require one payment per month. They do, however, work to ensure that creditors get their money, and their goal is typically to help you become debt free in five years or less.
All three types of debt consolidation loans are great ways to help improve your financial situation, but you should use them in conjunction with other efforts to improve your overall financial situation as well. If you’re looking to improve your credit score through consolidation, start by talking to your creditors about making your minimum payments on time and scheduling regular credit card payments. If you have difficulty managing your money, talk to your debt consolidation lender about having you establish a budget and learn to spend your money more wisely. Once you’re financially stable, you may be able to refinance your home equity or take out a personal loan to consolidate your debt even further.