Debt Consolidation Loans

Television advertisements, the Internet and just about any other possible media that is funded by advertisements are full of companies offering consolidation loans.  Even your bank would like to convince you to use the equity in your home to pay off your debts.  Low interest rates and more automated loan services (thanks mainly to computers) have caused an explosion in the consolidated loan business.  However, be careful before you make a decision to borrow more money. 

In a nutshell, consolidation loans are nothing more than a way to pool all of your debt into one, low interest loan.  For example, if in addition to other bills, you have $3,000 of debt on one credit card with an interest rate of 12 percent and $6,000 of debt on a second credit card with an interest rate of 16 percent, you may only be able to make the minimum monthly payments.  With a consolidation loan, you could borrow $9,000 at an interest rate of 8 to 10 percent depending on your credit history, pay off your high interest credit card debt using the consolidation loan and pay only one low monthly payment at a lower interest rate.          

If you can afford the monthly payments and are willing to continue the payments for several years or more this may be a good option.  It also may be a cheaper option than what a non profit debt consolidation service can offer.  However, this option is really nothing more than swapping one form of debt for another.  If you are sure you have turned over a new leaf and will not continue to go deeper into debt just because the amount of money you owe per month is less, a consolidation loan may be a viable option.  If you are planning on using a home equity loan to pay off your credit card debt there is an additional twist. 

When you use a home equity loan to pay off credit card debt you are swapping unsecured debt for secured debt.  In bankruptcy proceedings, secured debt usually cannot be discharged so if you default on a home equity loan the financial consequences could be more damaging than if you did not pay back your credit card.  Also, home equity loan lenders are more likely to pursue your case more vigorously and have more legal grounds to collect their money. 

Benefits: No bankruptcy on your credit report, one monthly payment and no required legal fees.  Drawbacks: Often long payback period (several years or more), you could be transferring unsecured debt for secured debt and unless you turn over a new leaf, you may not be changing the basic behavior patterns that got you in a pickle in the first place.