Debt consolidation is a way to collect all your individual debts and lump them into a single loan. It works well to combine overdraft, credit card, and automobile loans. By consolidating your debt you only make one payment to one creditor. Usually, you can negotiate better terms, a lower interest rate, and quicker payoff times. But is debt consolidation always the best idea for you?
When you consolidate your debt make sure you know if it is an unsecured or a secured loan. An unsecured loan is like a signature loan or a good will loan from a friend. You are not required to put anything on the line to guarantee the loan in the event you don’t pay. Money is loaned to you solely on your ability to repay. A secured loan requires that you offer a piece of collateral as insurance, in order for the bank to lend you money. That collateral could be your house, your boat, or a sum of money in an account. If for any reason you don’t pay the loan back, or default, the bank has every right to take whatever you may have secured the loan with.
It is also important to know whether the interest rate on your loan is fixed or variable. A fixed interest rate remains the same until the loan is paid off. The interest rate you start out with will be the interest rate you end with. If the lender’s rates go up and down, it doesn’t matter, because you will have a fixed interest rate. The other type of loan is the variable interest rate. These usually have an introductory offer. The offer can last anywhere from three months to five years. After the offer expires your rate will adjust to a new rate. These loans are popular because the introduction rate is so much lower than other rates. It’s tempting to get a variable rate, but it’s a risk because ultimately you can be negatively affected by rate changes. Consider these carefully.
When you consolidate your debt, look at the bottom line. Many people don’t realize that their debt can cost them 200% more after they’ve made payments over time. The car you bought for $15,000 could end up costing you $45,000 in the end. If possible, get an amortization table on your loan. This will tell you how much interest and how much principle you are paying with each payment. If you can make more than the minimum payment on your loan, you will get out of debt quicker and cheaper.
As with many life choices, the more you know about your financial options, the more likely you’ll be to make the right decision.
DMCC is a 501 (c)3 nonprofit organization committed to educating consumers on financial issues and providing personal assistance to consumers who have become overextended with debt. Education is provided free of charge to consumers, as well as personal counseling to identify the best options for the repayment of their debt. To speak to a certified credit counselor, call toll-free 866-618-3328 or email firstname.lastname@example.org.