What You Don’t Know About Debt Consolidation Could Hurt You

June 30, 2009 by  Filed under: Debt 

Debt consolidation may seem like the easy way out, but there are many things to consider before opting to use it. Many debt reduction counselors will tell you that consolidation will help you get current with your bills and debts. However, what you don’t know about consolidating your debt can really hurt you.
Consolidation is often advised when someone is paying down credit card debt. Since these interest rates can reach 22% or higher, even an unsecured consolidation loan from a bank can save you money on interest. On a $10,000 credit balance, a consolidation loan that is a measly 6% lower than your card’s interest rate can save you $600 over the course of a year.
One of the most highly advertised forms of debt consolidation is the home equity consolidation loan. This involves getting a loan, essentially a second mortgage, against the equity in your home. Your home’s equity is calculated by subtracting your mortgage balance from the value of your home. Ideally, this home equity loan is then used to pay off all your debts in one fell swoop, leaving you just one loan with a lower interest rate to pay off.
Sounds great, right? Think again. The credit card debt you’re trying to get rid of is what is called “unsecured” debt. Unsecured debt is debt that has no collateral backing it up. In other words, your credit card company won’t repossess the Prada bag you bought with your credit card if you can’t pay your credit card bill.
A home equity loan, on the other hand, is secured debt. This means that your home serves as collateral for the loan. Fail to pay the loan, and the lender will foreclose on your house. That’s right — your credit card debt could cause you to lose your home.
Even if you do pay off your unsecured debts with a home equity loan, you’re probably just applying a band-aid to a gaping wound. The same bad habits that got you into debt in the first place are still there. So, although your credit cards are paid off now, you will probably lapse into the habit of accumulating an ever-growing balance on your credit card.
If you’re thinking that you’ll just get an unsecured loan from the bank, you might change your mind. If you’re late on your credit card bills, it will show up on your credit report. Banks read credit reports before making unsecured loans. They’re not stupid, and if you can’t meet your current obligations, there’s no way they’re going to give you any money.
On the other hand, if you’re currently able to pay your credit card bills and still have good credit (but just want to get out of debt), you will likely be able to get an unsecured loan. Your good repayment history is just the kind of thing banks like to see.
Once again, though, you’ll have to change those bad habits that caused you to accumulate the debt in the first place. If you think you can still use credit cards, “just for emergencies”, you’re headed down a slippery slope, and you’ll end up in a worse place than you started in.
Your best bet, whether you decide to use a consolidation loan or not, is to start off by changing your spendy ways, getting rid of your bad financial habits. It may not be easy, and you may not know where to start, but many people have done it before you, and have even escaped debt without having to resort to consolidation loans.

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