The Perks and the Drawbacks of Debt Consolidation

Debt consolidation is where all of your high-interest unsecured credit card debt is paid off with a low-interest loan. The low-interest loan is made using the equity in your home as security or collateral. For many who are burdened by debt that may never get paid off, it is a very attractive alternative to bankruptcy. What are some of the perks and drawbacks to taking out a debt consolidation loan to give you debt relief? Let’s take a look at a few:

Perk : It is a lower-interest loan that makes paying off your debt possible. You don’t even need to be in debt trouble to take advantage of a low-interest debt consolidation loan. You could be in good standing with all of your credit card accounts but be carrying high balances that is hurting your credit. Plus, if you have ever been late with a credit card payment, you could be suffering under the universal default interest rate (usually around 28%) that they slapped on you just because they could. The debt consolidation loan usually stays at a fixed rate throughout the life of the loan because it is backed by the security of the equity in your home.

Drawback: It does not solve underlying personal financial problems. If the reason you are in overwhelming credit card debt is because you don’t save and you spend compulsively then a debt consolidation loan is only a band-aid on the real problem. You will get temporary relief but unless you learn to save and budget you will find that you quickly run up the balances on your credit cards once more.

Perk: You make one payment which is much easier to manage. When you have numerous credit card accounts with varying due dates and balances, it can be quite cumbersome to manage plus the risk of being late with a payment is much higher. And the late payments may cause your account to go into the default rate plus it will for sure add late fees to the balance.

Drawback: The debt consolidation loan is going to be very expensive. The term of these debt consolidation loans can be quite lengthy. The longer that a loan term is, the more expensive it will be for you in terms of interest. You could theoretically be paying more for paying off your credit card debts than if you enrolled in a debt management program that could get your debt paid off in 3 to 5 years without using the equity in your home.

Perk: Your credit may stay in good shape. If your credit card accounts were in good standing and only had high balances, then your credit should be in good shape. However keep in mind that the balances shifted from several accounts to one big account. You may have a hard time getting any new loans but you really should not be shopping for those anyways.