Pros and Cons of Debt Consolidation

Debt, in it of itself, is not a bad thing; after all, owing money is incorporated into the overall financial scheme of many a corporation. Excessive personal debt, however, is a terrible, horrible, no good, very bad thing. In recent years, to alleviate the suffocating pressure of debt, more and more Americans have been relying on consolidation loans. While these types of loans are a saving grace for some, there are significant drawbacks that should also be taken into consideration.

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First Things First: What is Debt Consolidation

Simply put, debt consolidation is when you take out a loan to pay off other loans. Yes, a loan for a loan. There are two types of debt consolidation: secured and unsecured. A secured loan is one backed by collateral, such as a house. Conversely, an unsecure loan is backed by only an agreement to pay. Since there is less creditor risk involved in a secure loan, interests rates are usually lower than that of an unsecured loan.

While taking out a loan to pay another loan may seem like a terrible idea, for some, it makes a lot of sense. For example, debt consolidation works for many who accrued significant debt while in school and now have a stable, profitable lifestyle. Like anything though, it’s important to weigh the pros and cons of taking this financial step.

How Does Debt Consolidation Work?

Once the lump sum from a consolidated loan comes through, a debtor uses the funds to pay off their previous high-interest loans or credit cards. The borrower then continues paying monthly, but at the lower interest rate on the single consolidated bank loan. Since the debt is now spread out over a longer period of time, the monthly amount is typically smaller.

Pros of Debt Consolidation

Lower Interest Rates

In most cases, interest on unsecured loans from a bank is less than the rate you’ll receive from a credit card company. Secured consolidated loans are even safer for a lending institution: if a home is used as collateral, the owner signs a waiver of foreclosure in the event payments are missed; if another asset is used to back a loan, the creditor will simply take possession of said item and sell it to regain their funds.

Simplify Payments

One of the worst things about bills is that there are so many of them; walking to the mailbox and pulling out a stack can be soul-sucking. When you consolidate your debt, there’s only one bill once a month. This reduces the chances of paying late and incurring extra fees.

Cons of Debt Consolidation

You Could Lose Your Home

While lower interest rates and smaller monthly payments sound peachy, there are risks involved…especially if you haven’t truly solved the base cause of your excessive debt. If you default on a consolidated loan taken out against your house, you will lose your home; and losing your home could be the beginning of even greater financial crisis.

Not so Hot for the Credit Report

Student consolidated loans aside, borrowing money to pay off a previous loan never looks good on a credit report. Remember, an unhealthy credit report will haunt you for at least 7 years, if not more.

If you’ve discovered and healed the root cause of your overspending, loan consolidation may very well be a sound, viable option. If you’re considering consolidation as a temporary stopgap, think long and hard about the potential ramifications; in addition, it’s a good idea to seek out a qualified number cruncher to help determine if consolidation debt relief is the best option for your circumstances.