A debt consolidation loan can make sense with low interest rates and loosening credit standards, but do your homework. Image: CC lemonjenny/Flickr
If you’ve ever considered a consolidation loan to facilitate credit card debt reduction, now is a good time. Banks are reported to be loosening credit standards and interest rates are very low. However, make sure you’re consolidating debt for the right reasons, and do your homework to get the best deal.
Be aware of debt consolidation risks
Debt consolidation usually makes sense on paper for someone struggling to pay off credit card debt. Credit cards are the most expensive form of borrowing. They even have a higher interest rate than an unsecured personal loan through a bank. A strategy adopted by many people to consolidate debt is achieving lower monthly payments and a lower interest rate by using their home as collateral. This is the primary risk involved with consolidation loans: taking unsecured credit card debt consolidating that debt into a secured debt. If for some reason the borrower defaults, the lender takes the home.
What is your borrowing strategy?
Borrowers have to think a debt consolidation loan through to the end. When it comes to uncomfortable debt, relieving the symptoms does nothing to cure the disease. Simply wanting a lower monthly payment to improve cash flow is not a good borrowing strategy. Often a lower monthly payment means a longer term, which adds up to paying out a lot more money over the life of the loan. But simplifying debt reduction has its value. One payment at a lower interest rate can reduce the risk of missing a payment and help build or maintain a decent credit score.
Doing debt consolidation right
Debt consolidation, however convenient it may appear, is not a quick fix. Borrowers have to do their homework. Most importantly, make sure you know your credit score. Then analyze your debt situation. List all your debt and minimum monthly payments, plus the interest you’re being charged. Look on your credit card bills at the feature showing how much you need to pay each month to retire the debt in three years. Is a debt consolidation loan still a good idea? Be sure that you know what kind of interest rate your credit score qualifies you for. Shop around. Compare interest rates, monthly payments and fees. Compare your current monthly payments with the debt consolidation loan payment to make sure you’re getting a better deal.
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