Debt Consolidation Isn’t All Bad
I know that on many occasions I have cautioned against the use of debt consolidation loans for debt elimination. It isn’t that I’m against them entirely, its just that they are too frequently used for the wrong reason, by the wrong people, at the wrong time.
Debt consolidation loans are one of the fastest ways to eliminate the burden of crushing debt. Here is the problem. If you have 80 thousand in equity in your home, and you borrow money against it to pay 40 thousand in credit card bills, are you sure that you will be able to continue to make the payment. The idea was debt elimination and that hasn’t happened.
Realize that now, its no longer an unsecured debt! It’s secured by a hard asset that can be foreclosed on if you don’t pay. If you keep your credit cards open, will you be in the same situation in a year, two years. Buried in credit card debt, unable to make the payment on your credit cards. And now, in addition, unable to make the additional payment on your home.
You can see my aversion to this type of plan.
Now, all that being said, there is a proper way to do this. It involves paying off the debt with the consolidation loan, CLOSING the credit card accounts, and making a systematic plan for getting the consolidation loan paid off quickly.
A huge problem comes up when we try to pay one debt, with another debt. Its only a short term solution. The debt hasn’t gone anywhere. It’s just changed in form from unsecured to secured. The upside to a consolidation loan is that the interest rate will probably be lower. This allows you to pay the debt off quicker. This plan requires a dicipline and will power that many people just dont have, and they end up getting in more trouble.
Your first line of defense should always be debt elimination through negotiation. If you choose to get a consolidation loan, find out what the interest rate and payment will be today, tomorrow, a year from now, two years from now, and so on. If your mortgage rep can’t tell you, find a new loan, or a new rep. Plan on being on a maximum five year debt elimination program. Can you pay off the loan within 5 years, and still cover all of your other expenses. This requires knowledge of what your expenses and income are, and some budget planning.
In addition, can you avoid incurring any more debt. Thats a tough one for most people.
If you take a loan with an adjustable rate, understand that mortgage interest rates are rising. The payment and the rate will go up. Be realistic, and use good judgement. When someone tells you the rate is 1.2 percent, its just a “teaser” rate. You don’t need to ask when the payment or interest rate will go up, because anything that starts with a teaser rate, is bad news.
Debt reduction is good, debt elimination is better. Make a plan, stick to it and live a debt free life.
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