There are many ways that personal debt can get out of hand. Sometimes unplanned emergencies or interruptions to employment play a major role. In other cases, debt piles up gradually over time. A point comes when credit card balances are so high that only minimum monthly payments can be made, and the cardholder suddenly realizes that his or her credit card debt is increasing every month. Whatever the cause, out-of-control debt is stressful – and something most people don’t enjoy talking about. Denying or ignoring the existence the problem only gives the problem time to get worse.
What Are Consolidation Loans?
Consolidation loans are used to combine high interest unsecured debt, including credit card debt and medical bills, into a lower interest installment loan with a lower monthly cost than the combined costs of the consolidated debts. Consolidation loans come in many forms, and may be secured or unsecured.
How Can Consolidation Loans Help?
Consolidation loans provide many potential advantages. Some of these include:
- They stop the upward spiral of the balances on high interest/high balance credit card debt – where minimum payments do not produce a balance reduction;
- They can reduce the likelihood of costly late or missed payment charges;
- They can eliminate embarrassing collection calls;
- They may take enough pressure off the monthly budget to permit regular contributions to a “rainy day” savings account;
- Making payments on your consolidation loan on time and in full month after month can strengthen your credit report and FICO credit score;
- An improve FICO credit score and a steady reduction in total debt, may open the door for a future consolidation loan at a lower interest rate, significantly reducing the time and cost required to attain debt-free status.
Consolidation loans can be an invaluable aid meeting the challenges of high monthly debt payments. As helpful as they can be however, consolidation loans don’t always work out to the borrower’s long-term advantage. Here are some factors to be aware of:
- When debt problems are the result of poor financial management skills or lack of spending discipline, a consolidation loan can create a path for making a bad situation into a much worse situation;
- While debt consolidation loans lower the monthly payment required to service the consolidated debts, consolidation loans generally spread the payments over 3 to 5 years, resulting in a substantial increase in the total cost of repaying the consolidated debts. That increased cost represents dollars that won’t be available for vacations, long-term savings, and leisure activities;
- Consolidation loans are normally used to pay off unsecured debts. Secured debts such as mortgages and automobile payments will still need to be made. If no savings reserves are available to help the consumer through the inevitable financial emergencies and “tight budget months” consolidation loans may themselves become sources of the late payment fees they were intended to prevent.
Avoiding the above problems, and fashioning a consolidation loan that works for the long term benefit of the borrower is not always a simple task. Professional debt counselors from accredited nonprofit agencies can provide valuable advice to help you choose between available consolidation loans.
While consolidation loans are convenient and often quite helpful over the short run, there are other options worth considering. Some of the more obvious of these include:
- Talking directly to the creditors that hold your most troublesome debts. In many cases they can be persuaded to offer improved loan terms if they believe that better loan terms will increase the likelihood of receiving the money you now owe them in a timely way;
- Sometimes simply tightening your belt for a month or two and focusing every cent you can on paying down your most costly credit card debt is actually a cheaper and less stressful approach to lowering your debt burden than using a consolidation loan:
- Picking up a temporary part-time job evenings or around the holiday seasons may not be as onerous as you think. Aside from the possibility of meeting some nice new people, you get to apply the extra earnings directly to your debts. Plus, you’ll have less time to go wandering around shopping malls or other high risk places. It’s an approach that has worked for many people.
In addition to these “do-it-yourself” alternatives to consolidation loans, there are companies that offer so called Debt Management Programs (DMP’s) that involve making a single affordable payment to a professional within the company, who uses the guarantee of a share of that payment as an inducement to get your creditors to forgive a portion of your debt or offer substantially improved loan terms. These programs usually involve a substantial upfront cost, and retain a portion of each monthly payment. Besides being expensive, these programs can severely damage your credit score.
Finally, for some individuals filing for protection under Chapter 7 or Chapter 13 of the US Bankruptcy Code represents the most realistic approach to regaining control over accumulated debt. Bankruptcy is not designed to be a particularly enjoyable process, but it does give successful petitioners a chance to start over with a clean slate.