Debt consolidation programs are usually just a big loan that pays off other smaller loans. They can be very beneficial to borrowers, but these programs also have their pitfalls.
When to Use Debt Consolidation Programs
Debt consolidation programs are good for a few situations. If you are paying several different loans off, your life may be easier if you consolidate everything into one loan. You’ll only get one monthly statement and make one payment.
Also, you’ll find that your monthly debt payments decrease if you use a debt consolidation program that stretches your payments out over a longer period of time. This means that you’ll pay out less each month and you can free up some cash.
A tempting (and sometimes successful) strategy is to use a debt consolidation program to manage various high-rate revolving debts. As an example, you might have numerous credit card balances with high interest rates. With a debt consolidation program, you might be able to get a handle on that debt and lower the interest rate (APR) that you’re paying. In general, credit cards have higher rates and secured loans (such as home equity loans) have lower rates.
Things to Remember About Debt Consolidation Programs
Using debt consolidation programs can help you or hurt you. You should be very aware that all these programs do is shift your debt – a debt consolidation program does not eliminate your debt. You owe the money and will have to pay it back sooner or later.
One pitfall of a debt consolidation program is that you may feel like you have less outstanding debt. For example, you’ll notice that your credit cards once again have generous amounts of available credit. If you use this credit you’ll only dig yourself into a deeper hole.
You should also be aware that you may end up paying more total interest if you use a debt consolidation loan. If you stretch out your payments over a longer period of time, it is possible that your total interest cost will be higher. Of course, it may be worth it to you if you can more easily manage your cash flow today, and in some cases you'll pay a lot less in interest if your consolidation loan has a substantially lower interest rate.
- See the effects of longer repayment or lower interest rates with our Loan Amortization Calculator
Finally, remember what you’re risking by using one of these programs. Often, you’ll use a home equity loan or a home equity line of credit to consolidate your debt. Those loans are appealing because you can borrow a lot, and they may provide some tax benefits. But the consequences of falling off the payment schedule can include the loss of your home in some cases. Credit card companies, on the other hand, can’t take your home because you never pledged anything as collateral. However, if you pledge your home, as is required in a debt consolidation program with a second mortgage, then your house is fair game for a foreclosure.
How to Find the Best Debt Consolidation Programs
There are a variety of choices, and you should shop around to find one that fits your needs. If you need some ideas on where to start, try this plan:
- Local credit unions or banks that you already have a relationship with. These are reliable sources that are likely to give you a fair deal.
- Banks that you don’t already have a relationship with. They might offer you a good deal in order to win your business.
- Borrow at Person to Person lending sites
- Mailers offering debt consolidation programs. These lenders already want your business – they’ve mailed you an offer because something about you fits into their desired profile. But only work with a reputable institution that you know you can trust -- some of this unsolicited junk mail can get you into a bad deal. If you've never heard of them, watch out.
- An internet search for “debt consolidation”. Just be extra careful with anything you find. Search for reviews and scam alerts related to any company you might work with.