If you’re experiencing financial hardship because you have too much debt to manage successfully in your budget, you may be looking at debt consolidation loans as one of your options for debt relief. A debt consolidation loan allows you to consolidate unsecured credit card debts into one low monthly payment at a much lower interest rate than your high interest credit cards. You pay less each month, but in the meantime you may also be able to get out of faster because your debts are not growing as fast with interest added.
Debt consolidation loans are not your only option to consolidate your debt, but they do provide a means to consolidate on your own. This typically makes them highly attractive to consumers, because they can solve their debt problems on their own. However, making a debt solution work on your own comes with certain risks you have to be aware of before you decide if this is the right solution for you.
A debt consolidation loan basically works like this:
- You take out a personal loan from a bank or other lender; a credit check and the normal application process for a loan will apply.
- You use the money you receive from the loan to pay off your credit card debts completely.
- With your credit card debts paid off, the only debts you should have left are this loan, as well as things like your mortgage, auto loan payments, student loan payments, and any secured debts you have.
- Once you pay off the loan, your credit card debt is eliminated and you are back on track with your finances.
One of the biggest problems with a debt consolidation loan comes in Step 4. Most consumers have a hard time avoiding their credit cards until the loan is paid off. If you start spending money on credit before you pay off the loan, you are effectively working against your own debt solution. If you spend too much, you may end up in the same situation where your debt payments are too high each month to afford. You have to be able to commit to avoiding credit entirely in order to be successful.
The other main problem comes in getting the right terms when you are applying for the loan. You will need extremely strong credit scores to qualify for the right interest rate and terms on an unsecured debt consolidation loan. If you credit scores are low, the interest rate will be too high and/or the payment schedule won’t work for your budget. You could make your financial hardship worse if you use an unsecured debt consolidation loan when your credit scores are too low.
There is a secured debt consolidation option with a home equity loan, but financial experts warn against using your home to secure your credit card debt. While you can get better terms with lower credit on a secured home equity loan, you are putting your home at risk to pay your credit card debt. If you get into a situation where you can’t afford to pay, you could lose your home as a result of your debt solution. If you cannot qualify for an unsecured debt consolidation loan, consider contacting a nonprofit credit counseling agency to discuss other options you have for consolidation instead of looking into home equity loans.