Understanding Debt Consolidation Options

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Men and women might find they are on the verge of bankruptcy because of circumstances beyond their control. Others find their financial footing is shaky and they need to get things under control before they reach this stage. Regardless of why a person looks for debt relief, debt consolidation needs consideration as a viable option. What is debt consolidation? How does a person know if this is the right choice for their specific circumstances?

What is Debt Consolidation?

Debt consolidation involves securing a loan to pay off existing debt. Most debtors roll everything into this loan other than their mortgage and possibly their car loan. Others find certain debts come with a lower interest rate and choose to exclude these debts from the consolidation loan. They roll the debts with higher interest rates into one financial product to lower their interest rate, pay the debt off quicker, or make it easier to manage their finances. The loan means they only have one payment to make each month, which many people find simplifies their budget and ensures they don't overlook a payment. Although there are options for debt relief, many debtors find this solution works best for their unique situation.

Secured or Unsecured?

The first things debtors must decide involves the loan used for debt consolidation. Secured loans serve as one option, and debtors find interest rates are lower with this choice. However, the debtor puts up collateral to secure the loan, and this lender takes the collateral in the event the loan payments aren't made as agreed. A mortgage loan provides a good example of a secured loan. If the borrower doesn't make the monthly mortgage payments, the lender repossesses the home. Unsecured loans come with a higher interest rate but require no collateral. Credit cards serve as one form of unsecured credit. Debtors need to compare secured and unsecured loans to determine which to use for relief.

Debt Consolidation with a Secured Loan

Debtors find they have many options when merging debt using a secured loan. Some men and women opt to finance their home or take out a home equity line of credit. Other people decide they wish to secure a loan with an alternative asset, such as their vehicle or a 401k loan. Life insurance policies with a cash value offer an alternative for those wanting to consolidate debt, although the policy must allow for this and the debtor must meet any requirements set forth in the policy. Financing firms loan debtors money if they can back it with an annuity, lawsuit claim, or lottery winnings. Should a person secure their debt consolidation loan with one of these assets?

Using a Secured Loan to Consolidate Debt

Secured loans allow a debtor to lower the interest rate they pay, in most cases. The lender knows they have means of recourse if the debtor defaults on the loan, so they are taking on less risk. The debtor benefits from the lower payment and only has one payment to make each month. Depending on the loan obtained, the debtor could find the payments are tax deductible. Having one payment each month that is lower than the debtor was paying helps. However, debtors must know the drawbacks of a secured debt consolidation loan before moving forward.

Consolidating unsecured debts with a secured loan comes with one gigantic risk. When the debtor doesn't make payments as agreed, the lender retains the right to take the pledged property as payment on the loan. This means the debtor loses their home, car, retirement fund, or whatever they used to secure the loan. Even when the debtors make payments as agreed, the debtor could find it takes longer to pay off the original debt after consolidating it. This means they pay more interest on the debt, even when the monthly payment drops.

Consolidating Debt with an Unsecured Loan

Debtors find unsecured loans are harder to come by today, and only those with very good credit get the best interest rates. For this reason, many debtors opt to take out a no- or low-interest rate credit card to merge debt rather than obtaining an unsecured personal loan. What benefits and drawbacks can one expect when they select this option?

With an unsecured loan, debtors know they aren't putting assets at risk to relieve their financial burden. Many debtors find the interest rate ends up being higher than they would get with a secured loan, but they still pay less each month as the rate on the loan remains lower than the interest rate of the debts being consolidated. The payment also comes in lower each month.

The problem debtor’s encounter when trying to get an unsecured debt consolidation loan revolves around finding a lender willing to work with the debtor. Many men and women in need of debt relief find they don't qualify for an unsecured loan. Those that do find a lender discover the interest rates skyrocket, as the lender raises the rate to correspond with the level of risk it is taking on. This may result in a payment that doesn't provide the needed level of relief.

Credit cards offering balance transfer options or no-interest or low-interest introductory offers need to be carefully considered. While the offer might look great on the surface, read the fine print. If the lender charges a balance transfer fee, the debtor might find the savings are less than expected. Furthermore, credit card companies often allow borrowers to use the card for other charges if funds remain on the card following the balance transfer. The debtor then makes the payment each month only to find the payment goes to the transferred balance first. Interest continues to accumulate on the new debt added once the transfer was complete. This significantly adds to the interest paid. Finally, the introductory period must be carefully considered. Rates typically jump once the period ends. If the consolidated debt hasn't been paid off, the internet could be costly.

The Psychological Effects of Debt Consolidation

Individuals who merge debt into a single loan with a lower payment each month find they get relief both emotionally and financially. However, they may become overly confident when it comes to their financial situation. Don't allow this to happen. Never take on additional debt until they have paid the consolidation loan in full. Doing so starts the cycle again.

Never take on any debt without understanding the pros and cons of doing so. Rushing into the process creates more problems than it solves. Seek advice to ensure you make the right decision for your situation.

 


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