What is Debt consolidation?
Debt consolidation is when someone who finds themselves with more than one credit agreement and wishes to either reduce the total amount of interest paid over the term of all debt, or they need to reduce their monthly payment and of course to avoid reoccurring late payment fees and charges. There are many pros and cons to debt consolidation though and you need to make sure that the debt consolidation loan that you are applying for benefits your needs and not just those of your credit lender. There are a few things you need to think about before deciding whether debt consolidation is the right choice for you.
When debt consolidation is a bad choice.
Loan companies and banks are trained very well in what they do and they realise before you do, that if you are going for a debt consolidation loan, then the likelihood is, you were struggling with your payments before and are searching for a debt rescue solution. That makes you a high risk, and the loan company will want collateral, which is usually your home. Whilst this makes you a low risk, as they have your home to recoup costs if you fold on payments, it leaves you in a worse state than before, when your loans were unsecured. This is because they own your home if you fail to pay the loan back.
The second issue with debt consolidation is that if you are applying for a solution from bad credit, then you have probably already mismanaged your money and research shows that most people who continue with debt consolidation end up in the same trouble with in two years. This is quite logical when you consider that people borrowing money are people who don't have the money for what they wish to purchase in the first place.
What you need to also be careful of with debt consolidation is that you are not looking solely at the monthly payment, as if it is stretched out over a longer term, the interest and payments per month may be lower, but the total that you pay back and for how long will be much more substantial than any previous loan for a shorter term. It does not make fiscal sense to make your financial status any worse,and when looking at the total amount that would be paid back over a long term loan, such as a 25 year mortgage, is a lot larger than on an unsecured 5 year loan.
Also make sure that you are not paying interest on top of interest. You will find that sometimes the very company that you have your original debt with, will offer you a consolidation loan, because by reapplying for a loan and settling the current loan, you are making them money. This is because they usually have at least one months interest charge as a settlement fee. This will be moved on to the new loan and so you will pay interest on top of interest.
When debt consolidation is a good choice.
Debt consolidation can be a good thing when it is saving you money in interest over the length of the loan. If you have 2 or 3 credit cards on high interest rates, with credit cards having typical interest rates of 16.9%-29.9%, and you are typically paying back only the minimum payment each month, the loan will never be repaid and the interest will be enormous. This will only be exasperated when another financial dilemma comes along and your debt increases yet again, causing a snowball effect on your disposable income. This is just the right time to get a debt consolidation loan as you will know exactly how much interest you will pay on the whole amount. You will also know exactly how long it will take you to repay this back, leaving you with one single monthly payment and no more overdue charges for being late or missed payments.
You can avoid a debt consolidation loan
You can avoid having to do a debt consolidation loan if you have reasonably good credit rating and then you could apply instead for a 0% credit card, balance transferring the balance of your existing credit cards on to the new 0% credit card. This would only be a good idea if you can be strict with yourself and split the balance over the months you have 0% for, meaning you pay off the balance before incurring any interest. Most credit cards will charge you 3% on balance transfers. Never do this if you can not trust yourself to go off and not pay the self dedicated payments, as all that will happen is you will be in a financial mess at the end of the 0% term. The best way to do this if you have the financial ability but not the will, is to get the 0% credit card, set up a standing monthly order payment, as suggested, divide up the balance by how many months your 0% rate exists for.Then to avoid extra spending, cut up the credit cards. If you use these 0% credit cards, the credit company have what they want as they balance this 0% deal against the fact that if you look at the purchase interest rate on these credit cards, they will be phenomenally higher than a regular credit card. Which is how they make their money on these offers.
The snow ball method to deal with debt
The way that has been used lately by debt counselors to deal with debt, is to advise you to pay off all the smaller debts first, and then deal with the next size debt. So if you have a store card, clear that and then move on to your lowest balance credit card. The relief at seeing less and less commitments keeps you motivated to sort out all the other debts.
If you feel that your debts are all too much and you can't manage them at all, or are not really financially minded, then you can and should go for Debt counselling.
In the UK the Consumer credit counselling service would be a good place to start. They are a registered charity, so they have no vested interest in any money.