This is the second in a series of posts regarding the alternatives to bankruptcy. The series will discuss debt consolidation, debt settlement, mortgage modification, and debt management programs.
What are the Pitfalls of Debt Consolidation?
There are several pitfalls to watch out for when considering debt consolidation. The interest rate on the new loan, the length of the new loan, hidden fees associated with the new loan, and potentially turning unsecured debt into secured debt.
One of the biggest key indicators to look at is the interest rate on the new loan. If your credit card is charging you 20% interest and your consolidation loan is 10% interest, it might help with lowering your payments and reducing the amount of overall interest you pay. You also want to keep the interest rate in mind with federal student loans. In the past, rates have fluctuated depending on when the loans were taken out and the federal consolidation loan is based on an average of those rates. If you have a high balance at a low rate, you need to look and see what your new interest rate is going to be before you consolidate.
However, the next thing to look at is the length of the loan. If you have a lower interest rate, but are spreading the payments out over 20 years (or longer), you may end up paying a lot more in interest, even with a lower interest rate. So, looking at the interest rate and the length of the loan together are important steps to understand the total amount you will owe.
Also, watch out for hidden fees in your new loan and make sure you consider the overall cost. For example, if you use a home equity line of credit, there may be an appraisal required or an origination fee. Just be aware of the fees and look for anything that could cost you more money.
Finally, turning unsecured debt into secured debt can be a big problem for some people that use their homes to obtain the consolidation loan. When you have unsecured debt (credit cards, personal loans, etc.), the creditor just has your word that you’ll pay and there is no collateral involved. Once your house is used to secure your consolidation loan, the creditor could potentially foreclose on your house in order to recover the loan payments if you default on the loan.
This is just a basic overview of the pitfalls of debt consolidation and is not legal advice specific to your situation. If you are considering bankruptcy or alternatives to bankruptcy, you should speak with an attorney in your area for legal advice.