The issue of consumer debt is a very real one, and the options of debt consolidation aren’t talked about in the mainstream media to quite the extent that they should be. That is because the credit card industry and others have a vested interest in you staying in debt as much as possible for as long as possible.
And they are even more interested if you have your debt spread out amongst many different financial instruments, all of which run at varying interest rates. For consumers that want to slay the debt demon once and for all, there’s only one viable solution if repayment is still possible and that is debt consolidation.
In this article, we will discuss the different types of debt consolidation out there as well as the advantages of debt consolidation, and the risks of debt consolidation.
This information should enable you to begin the hard and in-depth research towards finding a financial plan and solution that works for your current context.
What Is Debt Consolidation?
Debt consolidation is the process of bringing together multiple types of loans into one financial instrument.
For example, a mortgage is considered a secured loan because it is tied to a physical asset. Therefore, if you fail to make payments, the physical asset can be sold to recoup the lender’s losses.
However, an unsecured debt, like a credit card, is not tied to a physical asset. As a result, it is much harder for your lender to get back any money lost on the loan.
Typically, unsecured loans carry much higher interest rates than secured loans. With that being said, unsecured loans can often reach astronomical amounts just like mortgages and car loans but their interest rate also remains high.
In financial terms, an unsecured loan is a tough thing to justify given its high costs. When you move towards consolidation, you typically leverage an asset such as a home or car towards a lump sum loan that you then use to pay off unsecured lenders.
For the remainder of this article, we’ll give an overview of the ways you can obtain debt consolidation through either a secured or unsecured loan.
Additionally, we’ll discuss the advantages of debt consolidation using this method as well as the associated risks of debt consolidation.
Unsecured Versus Secured Loans In Debt Consolidation
The two major paths to debt consolidation include secured and unsecured loans.
For example, if you want to consolidate credit card debts, you might do so by placing them all onto one credit card for an unsecured loan that achieves the goals of debt consolidation.
This is often the route you will have to take if you don’t have an asset to borrow against.
Getting a secured loan to consolidate your debts is ideal, but the interest-rate reconciliation achieved by debt consolidation is a benefit of both. Naturally, you would want to consolidate at the lowest rate possible.
Debt Consolidation With A Secured Loan
If you choose to consolidate your debts via a secured loan, you get the benefit of one easy payment and a lowered interest rate.
Furthermore, if the loan is taken out against your home, there might even be tax benefits to paying off debts this way. This is because payments towards home loans are often tax-deductible.
What are some of the disadvantages of consolidating with a secured loan?
If you are moving unsecured debts to a secured note, then you are putting up whatever property that is listed as collateral to make sure that debt is paid.
An unsecured debt often cannot collect against real property without going to court or some other process.
However, a loan against a home or a car can be resolved quite quickly if you decide not to pay as you pledge that asset towards the satisfaction of any debt owed.
They don’t need your permission to take it. This means you need to consider your financial situation and what works best for you. In terms of paying off debts, a home loan usually takes the top spot, and unsecured debts fall beneath that.
Knowing that hierarchy, make sure whether or not you want to elevate something unsecured to the level of an asset backed loan.
Furthermore, you want to make sure you are not paying a higher interest rate or paying more over a longer period of time. These will both cost you money.
If the goal is to save money, you have to pay attention to the specific terms of the loan before you sign on the dotted line. You might not be getting the deal you want.
Debt Consolidation With An Unsecured Loan
Now we’ll discuss the advantages of debt consolidation via an unsecured loan.
Typically, the biggest advantage of debt consolidation with an unsecured loan is that no property is at stake in the loan agreement.
Also, it helps to consider what type of debts you are consolidating. If you are paying off credit card balances to get a consolidated payment at a lower rate, it makes sense to move those debts from one unsecured instrument to another.
The benefits of lowering your payment, your interest, and avoiding the risk of putting up collateral make an unsecured loan a great option for debt consolidation.
Even though lenders don’t ask for collateral, they will make an attempt to collect on the loan if the business relationship becomes unproductive.
Typically the higher the amount of the loan the more aggressive they will be in pursuing remedies to the default.
The cons of securing a debt via an unsecured loan include the difficulty of obtaining the loan. Additionally, there are considerably higher rates charged to unsecured loans versus secured loans.
Basically, the people most in need of unsecured debt consolidation often don’t qualify for an unsecured loan. This makes sense, right?
After all, the credit cards and other lenders are there to make money. It is up to you to be the financially savvy party because your lenders have done their homework.
Also, some balance transfer options might actually end up costing you more money. This is due to costs such as yearly or one-time activation fees as well as other high-priced items that will eat away into any interest rate savings you might achieve.
No matter what specific route you choose to debt consolidation, the overall process has some general pros and cons that will be discussed in detail below.
Pros Of Debt Consolidation
The major advantage and pro of debt consolidation is that you could retire your debt sooner. The second major advantage is that you can do this at a lower rate, thus saving yourself money over time. To see how much money you could save, do the math.
Often it takes very little convincing once you have set your financial situation down on paper.
Look at what you are currently paying and then imagine “what if” scenarios where you tweak various variables to see what happens to the overall outlay.
The third major advantage is that debt consolidation could make financial management much easier for you.
Simplifying your finances has many benefits outside of one payment and saving you money. It also relieves you of the mental burden of multiple payments and juggling various debts.
The fourth major advantage is that you could have a fixed repayment schedule. What this means is that your debt goes down by a certain rate each and every month.
This isn’t possible if you are using the credit card that you used to consolidate your debts. Therefore, it is listed last as it might not be an advantage depending on how you have structured your debt consolidation
Cons Of Debt Consolidation
Some of the cons of debt consolidation might not seem as obvious upon first glance.
For one, debt consolidation will not solve all of your financial issues.
Firstly, you need to help establish the practice and discipline that will enable you to succeed financially over time or you will constantly have problems with money.
Simply placing all of your debts into one bag won’t make you a savvier consumer. Furthermore, if you keep up your spending habits after you have done so, you could end up in a worse situation than before.
The second major con to debt consolidation is that there are costs associated with it as well, both apparent and hidden. Apparent costs are the rate you’ll be charged in interest and what your payment is.
The hidden costs are fees like balance transfer fees and others such as a longer term on the loan.
Figuring out whether debt consolidation is right for you requires some homework and due diligence on your part. Therefore, it makes the situation a lot more complex than simply getting a loan.
In most cases, debt consolidation will really help benefit your financial situation.
With lower payments or a reconciled interest payment, debt consolidation, like all financial matters, is contextually based and situation-specific. Be sure to do your due diligence and talk to your financial advisor before you consolidate your debt.
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