Debt Consolidation is taking out a loan to pay off numerous debts. Typically, this is done to receive a lower interest rate. A fixed interest rate on a debt consolidation loan is used for the convenience of paying only one debt.
Debt consolidation may be from a number of unsecured loans into another unsecured loan, but often it concerns a secured loan against an asset that acts as collateral, usually the borrower’s house. In this example, the mortgage is secured against the house. The lender provides a lower interest rate based on the asset’s value to pay back the debt consolidation loan. The risk to the lender is reduced so the interest rate is typically lower.
What Debt Consolidation Loans Are Not
Debt consolidation is a common method to gain control over increasing debt. However, it is not a risk-free loan or a guaranteed solution, so one should shop for the best interest rate. The advantages, which debt consolidation offers, also carry the potential for high interest debt from companies benefiting from refinancing charges in the debt consolidation loan.
Who Needs Debt Consolidation Loans?
Debt consolidation is often advisable when someone is paying credit card debt. Credit cards carry a larger interest rate than an unsecured loan from a bank. Debtors with property such as a home or car may get a lower rate through a secured loan by using collateral. The interest and cash flow paid towards the debt allows the debt to be paid off sooner, incurring less interest.
Things To Think About
Some debt consolidation companies can discount the amount of a loan. When the debtor is in danger of bankruptcy, the debt consolidator can buy the loan at a discount. A debtor should shop around for consolidators who will pass along some savings.
Surveys have raised concerns about the use of consolidation loans because many people are tempted to consolidate unsecured debt into secured debt. Although the monthly costs can often be lower, the total amount repaid is often considerably higher due to the extended period of the loan.
There are some alternatives to debt consolidation. Many people find it helpful to learn about all of the options with the help of a financial advisor.