Loan consolidation may seem like a one-stop solution for debt problems. It allows you to repay a large number of loans at once, and it comes with the promise of only one payment per month. However, loan consolidation can actually be damaging to your credit and financial health if not done correctly. Be sure to follow advice from credible sources prior to entering into a loan consolidation agreement.
Background
Loan consolidation is the process of paying off multiple loans with one, large loan. Since the old loans are paid off, they are removed from your credit score, and you have no further obligation to those lenders. Instead, you have an obligation for your new, much larger loan with a new lender. Many consolidation companies advertise the process as a simple way out of debt. However, the reality is you still owe your debts, but you now must pay a new lender. In some scenarios, you may even owe more after consolidation.
Risks
It is possible to have a larger principal loan balance after consolidating. This occurs when your existing lenders charge a premium for repaying your debt early. In addition to this premium, your lenders may report the activity negatively on your credit report. This can lower your score, forcing any remaining debts you have to adjust to higher rates. Further, since you have one new loan encompassing all of your previous loans, this loan is very high stakes. If you fail to repay the loan in full, any collateral you placed on your existing debts could be seized and liquidated.
Benefits
You may be able to consolidate some loans without any penalty. For example, you can consolidate federal student loans without any prepayment or credit repercussions. If you are considering consolidating, ask your existing lenders if there will be penalties for repaying your loans early. If not, you can move ahead with a consolidation knowing there will not be negative effects on your credit score or total debt.
Considerations
Never consolidate a low-rate loan into a high-rate loan. You may have several debts you wish to consolidate, each with very different interest rates. Consolidate only those loans with high interest rates into a new, high-interest consolidation loan. Pay off any other low-rate loans directly in order to save money. It is wise to pay down your consolidation loan, which will typically have a high rate, prior to paying down any low-rate loans.
Expert Insight
When you receive a call from a debt consolidation agency, remember this agency may be operating on a sales fee or commission, so it may not be your best source of debt consolidation advice. To learn about the risks and benefits of consolidation loans, seek a neutral third party's advice. Instead of relying on the consolidation lender for advice, use sources such as the Consumer Protection Agency or the Federal Trade Commission. These resources produce unbiased information, and they do not stand to profit from your decision.
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