What is a debt consolidation loan?
 | A debt consolidation loan is a personal loan from a financial institution or a lender to pay off multiple pending debts by replacing them with a single loan. Instead of multiple payments, debt consolidation offers only one payment to make every month, which helps individuals keep track of their finances as well as reduces the chances of missed or late payments. It is one of the most common and viable debt relief solutions to financially crunched people. Debt consolidation loans can either be classified as secured or unsecured. For secured debt consolidation loans, collateral is necessary to obtain the desired loan amount; most individuals use their homes as security in this instance. If the debtor can not make the payments - or if the payments are late – the debtor could lose their home. Conversely unsecured loans do not require collateral, and are based entirely on the perceived character and capacity of the borrower to repay the loan amount, but usually present a much higher interest rate. |
Debtor should be wary that the costs of debt consolidation loans and similar programs such as Credit Card Consolidation can add up. In addition to interest on the loans, debtors may have to pay "points," with one point equal to one percent of the total amount borrowed. Still, these loans may provide beneficial tax advantages that are not available with other types of credit.
“By consolidating your unsecured debt with a home equity loan, you run the risk of losing your hard earned assets if you default on your payments. You will still pay the full balances on your unsecured debt and must have a low debt-to-income ratio to qualify.” -Federal Trade Commission: "Facts for Consumers"
The Right Candidate for a Debt Consolidation Loan and what they should know
The time to consider a debt consolidation loan is if you meet most or all of the following:
- You have multiple debts from different lenders and have problems managing sending checks to different creditors at different dates.
- You have problems staying current on the payments.
- Your existing debts have different interest rates but you would like to only have one interest rate on the total amount of debt.
- You want to reduce your monthly payout for the overall amount of debt.
- If you are a home owner and want to leverage your equity.
You should make you should have a very clear understanding of a few points before opting for a debt consolidation loan:
- Fees: Avoid companies that charge high fees before providing any services. Such companies might claim that they can provide debt relief, but in reality they might take advantage of you.
- Interest rate: A practical way to review the benefits of a debt consolidation loan is to take a look at the Annual Percentage Rate (APR). Interest rates on these loans vary, for instance, the interest rate charged on a secured loan is usually less than the rate charged on an unsecured loan.
- Monthly payments: Make sure that the monthly amount of repayment on the new proposed consolidation loan is in-fact less than the amount you were paying overall before the consolidation.
- Your credit score: Avoid lenders who are not clear on the issue that if you fail to pay the monthly payments on time, it will adversely affect your credit score.
What documents do you need to qualify for a debt consolidation loan?
After you have:
- Taken a realistic look at the total amount of debt owed.
- Worked out a monthly budget complete with income, expenditures, and an emergency fund.
- Worked out exactly how much you need to borrow to meet your needs.
You will need:
- A copy of monthly budget to determine if you can handle your loan payments.
- A steady source of income.
- And may require a co-signer or collateral (ex. car or house).
What are the disadvantages of debt consolidation loans?
Debt consolidation loans can be a good debt relief option, but it is important that the debtor stick within the budget guidelines. Consolidation loans will only solve the consumer’s debt problem if they stop overspending, or else they can end up worse off than they started in two or three years by running credit cards up to the same levels or even higher than they were before the debt consolidation loan.
Other disadvantages include:
- Debt consolidation loans allow you to pay a low monthly installment and interest rate but usually involve a longer repayment period, thus you end up paying more to become debt free.
- You have to provide collateral like your car or home in order to obtain a secured debt consolidation loan which means that if you fail to make the payment on time you might lose your assets.
- This additional loan to pay off can at times adversely affect the credit report.
- Debt consolidation loans can only offer short-term relief as the borrower still has to pay back the full amount of the loan plus interest.
- Does not stop borrowers from taking out multiple loans again or falling back into bad spending habits.
- Payback can take as long as 10 to 20 years depending on debt balance and ability to pay.
- A transaction fee is usually required upon closing or it is built into the interest rates.
- One must qualify for debt consolidation loans, and those who qualify are usually not debt settlement candidates. Contact Bay View Law Group today in order to review your financial situation in depth to find the best debt relief option for you.
