Pros and Cons of Debt Consolidation

What is debt consolidation?

Debt consolidation is a type of loan that can help individuals that may have found themselves with too many monthly payments and open lines of credit. With living costs rising, it's easy to find yourself in debt. While credit cards and loans may provide temporary solutions for financial problems, they can cause serious long-term financial problems.
There are many reasons why people seek debt consolidation to help them get back on their feet and out of debt. Some debt is reasonable, however, too much debt can create problems in many aspects of a person's life.
When it comes to a person's financial situation, too much debt can make it extremely difficult to buy a house, rent an apartment, buy a car, and simply afford the necessities of their daily lives. Excessive debt can dramatically bring down your credit score which can bring its own set of issues to be concerned with.
A low credit score saddled with excessive debt can bring negative consequences that are far-reaching beyond the financial realm. There are many emotional implications that should be equally considered. People who confront issues due to their excessive debt may feel stress, fear or panic, anger, and depression. They may live in denial and try to avoid their problems, but that only leads to further escalating the issue. The worst part about someone experiencing excessive debt is that not only may they feel the stress, fear, anger, and depression that may come with dealing with issues around their debt issue, it can hurt the people around them. Families can be torn apart. Divorces can result. Children may be inadvertently negatively affected on a day-to-day basis based on living in a household coping with living in excessive debt. Debt consolidation is part of the answer to helping make some, or hopefully, most of the issues get better. The first step is to confront the situation head-on. To stop living in denial and realize something needs to change in order to begin the process of climbing out of debt.
Someone who is seeking to start the process of debt consolidation has many options to consider depending on how dire the situation may be. Everything from creating a strict budget and sticking to it to bankruptcy is on the table when you are first considering how to confront excessive debt issues. There is always the option of a debt consolidation loan to help alleviate the issue, however, before we get to debt consolidation loan issues, let us explore some alternatives that may be considered in addition to a debt consolidation loan.

Credit counseling: Even if you are looking for a debt consolidation loan, it is never a bad idea to explore the idea of seeking help from a professional debt counselor. Before you do, however, you should be aware that there is a large difference between a non-profit credit counseling agency and a debt relief service. There have been many reports, according to the FTC, about scams related to companies promising consumers with significant credit card debt that they can negotiate on their behalf to settle and reduce repayment obligations to their creditors. The company will charge a large upfront fee and then will not work to resolve any of the debt issues that the consumer was contacting the agency about in the first place.

A non-profit credit counseling agency should be classified as a Nonprofit 501c3. These agencies can provide credit counseling services to help individuals review their credit reports, make budgets, design a debt management plan, manage money, bankruptcy counseling, housing counseling, loan counseling, and teach them how to use credit responsibly. If you contact one of these agencies you can be connected to a certified credit counselor who can work with you personally to evaluate your financial situation and help you find a path forward to confronting the issue. The counselor can recommend a debt management plan, debt consolidation, debt settlement, or bankruptcy.

Budgeting: It may sound simple, however, sometimes people find themselves in debt because they cannot manage their money well and spend too much money on items that could be deemed unnecessary. Dining out, clothing, expensive bottles of wine, are just a few examples of items that may not need to be purchased regularly. By sitting down and taking a hard look at where you can cut spending to create cash flow to devote to paying debts, you may be able to make some real progress over time.

Debt settlement/Bankruptcy: Before considering whether debt settlement or bankruptcy you should really speak to a certified debt counselor first to see if your situation truly merits this drastic step. Debt settlement is where you negotiate with your creditors to see if they will accept a lump-sum payment for less than what you owe. This may be a viable option for many, however, a debt settlement can cause your credit score to go down approximately somewhere between 75 and 100 points and it stays on your credit report for up to 7-years.

Bankruptcy is when all other options have been exhausted. There are two forms of bankruptcy, chapter 7 and chapter 13. Chapter 7 bankruptcy is when a bankruptcy trustee is appointed to sell your non-exempt assets to pay off as much debt as possible. Chapter 13 bankruptcy allows you to create a repayment plan that the court is sufficient to clear your slate of all your debts. The repayment plan can span anywhere from 3 to 5 years depending on what the court deems sufficient. Chapter 7 bankruptcy stays on your credit report for up to 10-years whereas chapter 13 bankruptcy can stay on your record for up to 7-years.

Debt consolidation loan: Debt consolidation loans come in two forms, secured and unsecured. A secured debt consolidation loan requires the use of collateral to secure the loan. Collateral is an asset that you own that holds significant value and is deemed by the lender as sufficient enough to secure the amount of money you are requesting.

When you offer an asset as collateral, the lender then will put a lien on that asset to secure the loan. If for any reason you are unable to pay back the loan, the lender then has the right to seize the collateral to recover the remaining loan balance. If the asset holds more value than the remaining loan balance, then the proceeds from the sale will be returned.

Secured loans are an option for borrowers who may not be able to qualify for an unsecured loan due to their credit history. Most lenders require at least a minimum credit score of 600 to qualify for an unsecured personal debt consolidation loan, while many will even expect a higher credit score of 660 or 680. If you have a credit score below 600, then you can always opt for a secured loan in order to qualify for a personal debt consolidation loan. There are some lenders that may offer you an unsecured personal loan even with a credit score as low as 560, however, the loan most likely will come with the highest APRs and include additional fees.

If you are considering a secured personal debt consolidation loan but you are wondering what types of assets may qualify as collateral, here is a list of some commonly used assets to secure a personal debt consolidation loan.

Real estate: If you own a home, second home, rental property, condo, mobile home, houseboat, or land, you can use either one of these options to secure a personal debt consolidation loan. This kind of collateral can be extremely risky and has severe consequences if you should ever happen to default on your debt consolidation loan.

Vehicles: Vehicles are a common asset used as collateral. If you have a secondary vehicle that you do not use often, that may be the least risky option, however, you can use your car, boat, RV, ATVs, and other valuable recreational vehicles as collateral.

Investments: Investments are always something you may use as collateral to secure a debt consolidation loan. Investments like stocks, bonds, and retirement accounts can be used as collateral, however, some retirement accounts like 401k retirement savings accounts may be exempt.

Collectibles: Gold and silver always make good collateral to secure a loan, however, items like jewelry, fine art, musical instruments, and antiques may also be considered.

If you are not considering or need a secured personal debt consolidation loan, then an unsecured personal loan may be a good option to help you consolidate your debt. An unsecured debt consolidation loan is fairly simple to get and can help you alleviate some of your financial stress.

When you consolidate your debts with a debt consolidation loan, you can combine multiple debts from various creditors all into one larger debt. This can simplify your finances by making it much easier to keep track of. When you have multiple monthly payments that need to be paid to different creditors, keeping track of all the different due dates, amounts, and interest rates can be overwhelming. With a debt consolidation loan, you will only have one monthly payment with one due date for one amount with one interest rate to keep track of.

Additionally, when you add up all the different monthly payments together, you may have been paying more out of pocket each month than the one single monthly payment a debt consolidation loan can bring. Maybe before you were spending a lot of money each month paying all those different creditors, with a debt consolidation loan you can ask for a longer loan term to help you if you are in need of a low monthly payment.

Whether you choose an unsecured or secured personal loan to help with your debt consolidation process, there are many advantages. But with everything, there are also disadvantages. Here are some of the pros and cons of using a personal loan to help you consolidate your debts.

Pros of debt consolidation

Lower rates available: Often when you start looking for a debt consolidation loan, you may find that the interest rates on the loans are lower than the interest rates on high-interest credit cards. Or, maybe when you took out a previous loan, your credit was much worse and now you have worked to improve your credit and you qualify for a debt consolidation loan with a lower interest rate. Consolidating all those high-interest debts into a new lower-interest debt may save you money over time.
One monthly payment: Instead of balancing multiple monthly payments across various creditors, you can have one easy monthly payment with one due date to be concerned with each month.
Build credit: By consolidating all your debts into one monthly payment, as long as you make the payments on time each month, you can continue to build up your payment history and improve your credit.
Repay sooner: Credit cards are revolving lines of credit with no pay-off date. Combine all those credit cards into one debt consolidation loan and you can know when exactly all your debts will be paid off.

Cons of debt consolidation

You may not qualify for a low rate: Ideally, you should find a debt consolidation loan that has a better interest rate than your current debts. However, if your credit score has gone down because of how much debt you have taken on, you may not find a loan with a lower interest rate.
Managing payments is more important: Payment history makes up 35% of your overall credit score. If you happen to be late or miss a payment on your consolidation loan, you risk doing even more to your credit than if you missed a single credit card payment.
Does not wipe away debt for good: If you take out a debt consolidation loan and wipe all the debt from your revolving credit lines but then you start using them again, you risk making your debt burden even worse.

When should you consider debt consolidation?

You should consider debt consolidation when you realize your debt situation is affecting your life in a negative way. It may not be easy to see at first, however, it could be something as simple as not having enough time to keep track of all the different monthly payments you have, and having one monthly payment would alleviate a lot of stress in your life and create more time for you to focus on other important matters.
Or maybe it is for financial reasons. Maybe you have been working on improving your credit score and now you can qualify for a much lower interest rate than what you have on all your different debts. Taking out a new loan to consolidate your current high-interest debts could save you money.
There are many good reasons to consider a debt consolidation loan, however, if you are struggling with your debt situation, you may want to consider seeking the help of a certified debt counselor in combination to exploring debt consolidation loan options.

Is debt consolidation worth it?

Debt or excessive debt is a problem that creates large problems in a person's life. Debt consolidation may be a great option for anyone who is struggling with debt who needs some help alleviating the burden. If you can find a debt consolidation loan that offers a monthly payment you can afford with a lower total loan cost than existing debts, it is probably worth it. Always do your research and compare total loan costs before making a decision.