What are the Pros and Cons of Debt Consolidation?
Taking out a debt consolidation loan can be a good option for anyone that finds themselves in a position where they find it difficult to meet their payments on their debts every month. If you are only meeting your minimum payments on a debt you will probably struggle to reduce the principal amount you owe and your debt could actually increase through added interest on your debt.
Debt consolidation could be a good option for you into managing your debts. Before you begin on taking on such a loan you should always seek advice from a professional adviser so that you fully understand the processes involved. Read on to discover the pros and cons of taking out a debt consolidation loan.
What is Debt Consolidation?
When you take out a debt consolidation loan, all of your smaller loans are placed into one manageable loan. This leaves you with just one loan to pay off every month rather than having to make several payments. The theory behind this is that one payment is much easier to maintain than several. By having one payment you are reducing the interest rate on what you owe and in theory you should be able to manage your debts more efficiently and completely pay off your debts much quicker.
You should not confuse debt consolidation with debt settlement. By taking out a debt consolidation loan you still pay your debts in full but there will be no negative consequences to your credit rating.
The Pros of a Debt Consolidation Loan
Lower Monthly Payments
Debt consolidation is as was mentioned earlier in this article taking out a new loan to pay off all your old debts. By doing this your monthly payments become manageable and you then choose how long you need to pay off your debts, the lower the monthly payment the longer it takes to pay it off.
The biggest advantage is you have more money available for your other needs once your debts are under control. It is much easier to make One Monthly Payment than Several
By using a debt consolidation loan to clear all your old debts into one manageable loan it is much easier to control and keep records of your incoming and outgoing payments making your money management an achievable task each month.
Raising Your Credit Score
By failing to pay your debts in a timely manner you will see a negative effect to your credit score. By consolidating all of your debts and paying what you agree to every month will see your credit rating improving over time.
Having Just a Single Creditor
When you have a consolidated loan all your debt payments are through a single creditor. Should you find yourself having a problem making a payment you only have to contact a single creditor instead of having to contact several creditors when you had numerous loans!
Taking Tax Breaks
An advantage to taking out a debt consolidation loan is that it means your tax could be affected. If you have used a home equity loan to pay off your debts then you could see a reduction in the interest rate you are paying on your loan.
The Cons of a Debt Consolidation Loan
You Could Lose Your Property
If your debt consolidation loan is a secured loan and you fail to make payments you could lose your property. If your consolidation loan requires you to provide collateral such as your house or vehicle then you need to ensure you make your payments on time.
Longer to Pay off Your Debts
By consolidating your debts it is highly likely that the terms of your loan are over a longer period of time than the original loans. You will have a lower monthly payment but your debt will take longer to pay off.
Higher Rate of Interest
If your debt consolidation loan is an unsecured loan the lender may well charge you a higher rate of interest to allow for the risk taken by the lender. You may end up paying as much in interest charges as the principal amount of the loan.
Fluctuations in Your Credit Rating
When you first take out a debt consolidation loan your credit rating will reduce quite significantly. This can be determined by factors such as the amount of debt you owe and your repayment history. The good news is that over time and with careful money management your credit rating will improve.
Secured or Unsecured Loans
Whenever you take out a secured loan (these are usually on a mortgage or could be used on a car loan), you pledge an asset of yours such as that home or car as security should you default on the loan. If you were to fall behind with your payments the mortgage lender could then come and seize that asset to foreclose on the loan.
On an unsecured loan, the loan is based on your promise to repay what you owe and not secured with property or assets that can be repossessed should you fail to comply with the loan and miss payments. Credit card debt is one of the main contributors to unsecured loans. You will find that unsecured loans have a higher rate of interest due to the higher risk of defaulting and are a greater risk to the lender.