Debt Consolidation
The concept and basic mechanisms of bad debt consolidation are much the same today as years ago. However, due to a dramatic increase in the number of people needing to consolidate debt, financial experts have modified existing programs, implemented new programs, and changed some of the rules. The way in which debt consolidation is now structured makes it possible for people to benefit from this financial tool but along with the good debt consolidation also presents some pitfalls that need to be understood prior to securing a loan.
We all know the global financial crisis that began in 2007 devastated the lives of millions of people. Throughout the country, people experienced job layoffs, home foreclosures, car repossessions, and failed businesses. Trying to survive while waiting for the economy to turn, many people depended heavily on credit cards. Although the economic situation today is slowly beginning to stabilize, the time people lived on borrowed credit card money was much longer than anticipated. This left people still reeling from the financial crisis that affected the world, but also facing new challenges associated with a personal financial crisis.
We wanted to start by addressing some of the primary benefits of a debt consolidation loan. Of course, to get the most from this type of financial solution, it is imperative that loans only be secured through reputable lenders. After all, the goal of debt consolidation is to provide people with an avenue whereby they can dig out from underneath debt. To accomplish this goal, lenders carry a large portion of the responsibility but as the consumer, you have both the right and responsibility to be actively involved in the process. This means finding the right lender, understanding the terms of the loan, securing the lowest interest rate, and learning all you can so educated decisions are made.
Debt Consolidation Basics
We wanted to offer a brief overview of what debt consolidation is and the way it usually works. With this, you would secure a new loan through your bank or credit union in a dollar amount large enough to cover outstanding debt. Typically, for loan approval, the lender would require you put up some form of collateral, usually a home. Now, some lenders will offer an unsecured debt consolidation loan but in this case, you would need excellent credit and preferably a longstanding business relationship with the bank or credit union providing the loan.
Eliminating Debt and Stress
The number one benefit of debt consolidation is the breathing room it provides. As each creditor is paid in full, the level of stress decreases while hope increases. Once all debt has been paid, harassing and embarrassing collection calls stop. Interestingly, many health issues and failed marriages share a common denominator – financial stress. Therefore, having the ability to get out from the burden of outstanding debt helps pave the way for you to rebuild your life without stress hanging over your head.
Credit Score
Every time a payment to a creditor is late, missed altogether, or the account is defaulted on, a report is sent to one or all three of the credit reporting agencies to include TransUnion, Experian, and Equifax. A special scoring system known as FICO is used to determine and represent a person’s creditworthiness. The higher the score the less risk is posed to creditors while the lower the score, the more difficult it would be to buy a home, get a car loan, secure a credit card, etc. In fact, insurance companies and employers now use consumer credit reports as a guide whether to sell a policy or hire that person for a job.
To creditors, along with insurance companies and employers, your FICO score tells a much broader story than just how responsible you are with debt. Although creditworthiness it the primary focus, if your credit score is poor, red flags would be raised that perhaps you are irresponsible, financially immature, or downright careless. Therefore, protecting your credit is crucial and with a debt consolidation loan, you could stabilize but also improve your FICO score.
Interest Rate
In most cases, the lender of a debt consolidation loan will offer a lower and fixed interest rate. Because of this, after the loan has been approved, you would have the ability to pay off creditors but also benefit from a lower monthly payment on the new loan. In fact, depending on the interest rate you lock into, the amount of savings could make it possible for you to pay extra money toward the loan’s principal each month, thereby paying the loan off earlier than scheduled.
As you can see, a debt consolidation loan provides multiple benefits but as mentioned, prior to signing on the dotted line it is essential to understand the pitfalls or in some cases, serious risk of a loan of this type.
Loss of Collateral
More than likely, to secure a debt consolidation loan you would be required to put your home up as collateral. With this, the lender would put a lien on the property, as a means of protection should you default on the loan. While we can understand why lenders need protection, you want to make sure you are in a good position to use the home as collateral.
The last thing you want is to take out a debt consolidation loan using your property for collateral but then find the loan was not enough to help you out of the financial crisis, leading to the home being taken over by the bank or credit union. Be honest about your situation and realistic whether a debt consolidation loan is going to be the right solution to help you get out of debt.
True Savings
When looking around at different lenders, you would see that most make the debt consolidation route appear to be the perfect solution for all people in all situations. Be careful not to become caught up in the hype of debt consolidation, choosing instead to analyze your situation to determine if using the loan to pay off creditors is actually a good plan. Remember, many creditors are more than willing to work with consumers, wanting to do everything possible to avoid losing money. Therefore, you may be able to negotiate lower interest, better terms, or some other solution that would work better than a debt consolidation loan.
Damaged Credit
As you saw above, debt consolidation can often salvage a person’s credit. However, choosing one larger loan to pay off multiple smaller debts to creditors could affect your credit score negatively. For instance, if you have credit cards that have been in your name for years and you intend to roll them into a debt consolidation loan, even if you had been late on payments or missed payments this could backfire.
The reason is that longstanding credit plays an important role in developing a good credit history so exchanging this long history for a new loan would alter the duration of your credit. Again, debt consolidation may ultimately be the right decision but you may want to consider negotiating with the credit card companies so you can get back on track but without throwing out a long, established history.
Repayments
You should also be honest and realistic about payments of a debt consolidation loan. More than likely, the reason you are now in the position of needing debt consolidation is that other debt was not managed properly. This is not to say that you were irresponsible with the different accounts simply that for one reason or another, you found yourself in a bad financial situation.
Once you know the amount of money you would need to borrow, the interest rate, the amount of monthly payments, and loan duration, sit back and look at the facts before you make a commitment. Think about the different scenarios you faced that put you where you are today, analyzing whether you could ever be faced with those same scenarios again.
To be honest, if your current situation with debt is due to financial mismanagement, prior to securing a consolidation loan it would be to your advantage to complete a financial management course. That way, the new loan would be taken out with an entirely new approach and attitude, making it possible to avoid repeating the same mistakes.
Fraudulent Offers
The last thing we wanted to mention specific to debt consolidation is that dishonest people and companies exist, preying on consumers in financial distress. Sadly, even with increased efforts, the number of people being scammed is on the rise. All over the country, people are being sent fliers and letters in the mail, and email messages online about incredible debt consolidation options.
Typically, these “offers” make incredible guarantees that seem too good to be true. Well, just as the old saying goes, “If it seems too good to be true it probably is”, any offer for debt consolidation that is exaggerated above what reputable companies are offering should be avoided and even reported to officials.
Sadly, because of the desperate situation, many people have fallen for these scams only to end up in more debt. This is why becoming educated about legitimate debt consolidation loans and other financial solutions are critical. With this, you would have the knowledge and awareness to avoid any “deal” that involves you sending money for them to save you money.