Debt Consolidation - Understanding The Risks
When a person has a number of outstanding credit card debts, the convenience of having them all rolled into a single debt through debt consolidation sounds like the perfect way to simplify trying to keep track of everything. Better yet, the debt consolidation will usually lower the overall payment as high interest credit cards are bundled together into a lower interest loan.
Before you opt for the ease of a debt consolidation loan, however, it's important to know and thoroughly consider the serious risks that accompany these loans. Chances are that the consolidation loan will require you to take out a second mortgage or a home equity loan. If you do this to pay off your VISA and MasterCard bills, you end up trading in unsecured debt for secured debt. The result is that if you default on your payments with the secured consolidation loan, you put your house at risk whereas if you defaulted on the credit cards, your credit rating will be adversely affected, but your house won't be in danger.
The real danger with using a consolidation loan is if an unexpected emergency arises. Most people have every intention to pay off their debts and the reason they look into consolidating their credit card debt is so that they can do this more effectively. An unexpected loss of a job or other situation that causes a sudden loss of income will quickly make the debt consolidation loan an even heavier burden since the house will be on the line.
Another growing concern regarding debt consolidation loans is they may not be better than the individual credit card interest rates. This is due to a couple of factors. Those who have various credit card debts, but have kept up on payments can often negotiate for favorable interest rates with their current credit card companies with the threat of moving their business with a transfer if not given a lower rate. These can be as good, if not better, than the interest rate charged by debt consolidation companies.
Another problem is those who are in deep debt often have the impression that a single loan will look better on their credit report than a lot of outstanding debt on different credit cards. In fact, consolidation will most likely initially have a negative effect on your credit rating. This is because a key portion to credit scores is the length of time you have had accounts open. By closing all your credit card accounts for the consolidation loan, your credit history significantly shortens.
Concern should also be focused on the spending habits that got you into the situation when you are considering a debt consolidation loan in the first place. Getting this loan will not magically solve the underlying issues that put all the debt on the credit cards and if not addressed, new debt on credit cards could soon appear. This will only increase the likelihood of default and putting your house at risk. Before considering this option, steps should be put in place so that a recurrence of the credit card debt doesn't occur.
Another aspect to be wary of when considering a debt consolidation loan is that there are more and more unscrupulous lenders out there trying to take advantage of your debt situation. Some will not fully disclose that you are in fact putting your house at risk with a secured loan. A growing scam is debt consolidation loan companies that guarantee you'll get a loan if you agree to pay an up front fee. The Federal Trade Commission say you should avoid any companies that make such a guarantee for an advance fee. While legitimate consolidation loan companies may require an up front application fee, they'll never guarantee approval of the loan in advance.
While there are a lot of negative points that need to be carefully considered, they don't mean there is never a situation where a debt consolidation loan is both appropriate and helpful. Depending on your circumstances, you may be able to lower your interest rates in addition to making them tax deductible. At the same time you may also be able to lower your monthly payments while still paying off the debt at a quicker pace. The key is to make sure that you fully understand the pitfalls and have put into place the necessary safeguards on the off chance that the unexpected happens.
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