An Explanation Of A Debt Consolidation Loan

By Author: Brain Jenkins
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A debt consolidation loan is a process of taking out one loan to pay off several other loans. There are advantages to doing this, such as financing the loan at a lower interest rate, or extending the life of the loan, both of which will lower your monthly obligations. Sometimes people will roll a variety of unsecured debt obligations over into another unsecured obligation. This is most common when someone transfers credit card account balances from several different credit cards to one credit card that has a lower interest rate. This is not, however, what most people think of when they consider a debt consolidation loan.

Most often, a debt consolidation loan involves taking a variety of unsecured debt and transferring it over to a loan against secured debt. To put into simple terms, the credit card or other debt is rolled into a loan taken out as a second mortgage against a home. The home serves as collateral against the debt. By providing the home as collateral, the borrower can obtain a lower interest rate than if he were attempting to consolidate his debt with no collateral. This is because the lender can force the ...
... sale of the home, through foreclosure proceedings, if the borrower does not repay the loan.

The Dangers of a Debt Consolidation Loan

Debt consolidation is not always the best decision for financial woes. While it is true that consolidating your debt can free up some money each month, there are many risk factors as well. The biggest, of course, is that you are switching from an unsecured debt to a secured debt. If you do not pay unsecured debt, you account may be turned over to collections, or you may even be drawn into a lawsuit, but it is unlikely that your financial history will be devastated. If you cannot repay a debt consolidation loan in which you have used your home as collateral, you will face foreclosure.

Foreclosure proceedings are devastating on a variety of levels. A foreclosure on your credit history is a huge black mark, which can take years to eliminate. The bigger blow, of course, is the loss of your home. It seems impossible to imagine, but, if you do not make the payments on your debt consolidation loan, even if you continue to make your mortgage payments, you do face losing your home.

Another, less apparent, problem with debt consolidation loans, is that by eliminating "dumb" debt, it is easy to forget it ever happened. Once those expensive dinners and spur of the moment shopping trips are rolled into a debt consolidation loan, and you are not looking at multiple credit card statements each month, it is very easy to fall into the same financial trap. In fact, by some estimations, up to 70% of people who consolidate their loans will find themselves with some amount of unsecured debt again in the near future. If you have not made plans on changing your financial future entirely, it does not make sense to consolidate your debts.

When Does Debt Consolidation Make Sense?

You should not let the pitfalls of debt consolidation loans scare you off. They do make sense for many people. If you have acquired a significant amount of debt that you need to pay off, such as through medical bills, it makes sense to consider a debt consolidation loan. Also, if your credit card debt can be ruled as youthful extravagance, and you are ready to change your ways, then debt consolidation can provide you with a financial option.

Only you can make the decision on whether debt consolidation loans make sense for your particular situation. What you should realize, however, that they are not free. Debt consolidation loans are subject to closing costs just as a traditional mortgage. You can sometimes reduce these by taking out the loan through the same lender that holds your current mortgage. Also, if you are struggling to make ends meet now, ask the lender what your monthly payments will be under the debt consolidation mortgage. If they are not substantially lower, either pass on the debt consolidation loan or ask if the repayment terms can be extended. It is one thing to risk a missed payment with unsecured debt, but in the case of a debt consolidation loan, where your home is on the line, you need to make certain that you can meet the repayment schedule.

Once you have weighed the pros and cons of debt consolidation, it will be easier to make a decision. For some, the benefit of paying off their debt is worth the risk of using their home as collateral, but for others, the risk is too great. It is a very personal decision, and regardless of your decision, it is important to have all of the facts about debt consolidation before taking the plunge.

About Author:

Brain Jenkins is a freelance writer who writes about topics pertaining to the mortgage industry such as a Mortgage Company.