Wednesday, October 12, 2005

How Does a Debt Consolidation Loan Work?

Find the Problem

    Before you start looking into debt consolidation loans, you need to take a look at your current situation and find out what got you into a debt problem. Was it an emergency or a one-time situation or was it months of overspending? Was there an income loss? There are many ways of handling debt problems, and answering these questions will help you find the correct solution.

What is Debt Consolidation?

    Debt consolidation takes the total of all your individual debts and combines them into one. In theory, if you had six credit card loans with an average interest rate of 18%, a car loan at 12% and you financed your furniture at 11%, you could consolidate all that debt into one loan at a lower interest rate. Then, you would only have one payment to make each month and it would be substantially lower than the sum of all the payments you were making on the loans before.

    There are problems with that theory though. In order to get that great interest rate, you have to have a great credit score. Most people with a lot of debt don't have a great credit score.

Home Equity Loans

    The most common debt consolidation loans are the home equity loan or line of credit. This is where you use the equity in your home to secure a second mortgage on it. You may be able to get a better rate, but you are putting a lien on your home. If you are temporarily out of work, you may soon not only be facing a debt problem but foreclosure too. Think long and hard about putting your home at risk. If you got into debt because of overspending, you will have to be very disciplined in order to avoid getting right back into debt and losing your home.

Other Alternatives

    If you don't own a home you may be able to get an unsecured debt consolidation loan. However, you will be paying a higher rate and fees. With this option, do the math and make sure you're really saving money. Another alternative besides the debt consolidation loan is credit counseling. They will help you find the problems that got you into the debt mess and find ways to get out of it. They will work with the creditors to reduce rates and fees and sometimes even the amount owed.

    Some credit counselors will even take your bills and you can pay them once a month. They in turn will pay the credit card companies the agreed amounts. This relieves much of the stress of dealing with so many bills. They will most likely make you get rid of your credit cards and learn to manage your debt. You will be charged for this service and your credit score may decline from the credit card companies accepting less than you actually owe. In order to find a reputable credit counseling service, ask questions and make them explain exactly what they are doing and why. If they are not making it clear then move on to the next one. Check the company you are considering with the Association of Independent Consumer Credit Counseling Agencies or the National Foundation of Credit Counseling.

0 comments:

Post a Comment