Many Americans consider loan consolidation to pay off credit cards and high interest unsecured loans. This strategy requires debtors to transfer outstanding debts into a new loan or credit card account with lower rates of interest.
The problem with loan consolidation is that it is often a temporary fix to a much larger problem. When debts become so excessive that people consider taking out a home equity loan it is smarter to look at the circumstances that caused financial overload.
Financial expert, Dave Ramsey does not recommend entering into loan consolidation. He provides examples of how consolidating debts into lower interest home equity loans actually costs more money in the long run. Not to mention, home equity loans place real estate at risk for foreclosure.
In Ramsey's example he explains how one couple consolidated three loans into one. Combined, these loans totaled $60,000. Loan duration ranged from two to four years and total monthly installments were $1,100.
When the couple consolidated debts their payment was reduced to $640. By all accounts that is a dramatic reduction, right? The problem is the couple had to pay loan installments for six years and essentially added nearly $6,000 in additional debt. Is it really worth it to pay thousands and extend payments for an additional two to four years?
Banks, credit unions, and loan consolidation companies aren't going to provide an analysis of the true costs of refinancing debt. Instead, they will show you how much money you can save monthly. The truth is you aren't saving any money at all. You're only dragging debts out for longer periods of time and racking up additional interest charges.
A lot of people turn to home equity loans when consolidating debts. This can be a very risky strategy because if something happens and you're no longer able to remit payments you could lose your home to foreclosure, even if you're current with your first mortgage. Do you really want to place your home at risk to save a few bucks each month?
Unless homeowners have impeccable credit there is high probability they won't qualify for a home equity loan. The mortgage crisis caused banks to tighten lending criteria. Today, borrowers need to have FICO scores of 720 or higher, along with a solid employment history.
Some banks offer debt consolidation loans to borrowers with lower FICO scores, but assess a higher rate of interest. As mentioned earlier, home equity loans are paid back over longer periods of time and can add additional debt.
Instead of taking out loans and extending payment terms, a better option is to reduce expenses or increase income to pay off credit cards and unsecured loans. This can be accomplished by establishing a household budget, eliminating unnecessary expenses, or taking a second job.
Many people will argue that it's nearly impossible to find one job, let alone two, but those who really want to get out of debt can find ways to generate additional income. It could be as simple as bartering for items you need but can't afford or eliminating unlimited cell phone plans that cost and arm and a leg.
Budgeting can be a painful experience for those who are used to whipping out credit cards for daily expenses, but the rewards are well worth the effort. Wouldn't you rather tighten the money belt for a few years than to remain in financial bondage for a decade?
We invite you to learn more about loan consolidation and overcoming debt through budgeting in our personal finance article library. We cover a wide range of topics including debt consolidation, debt settlement, bankruptcy, and credit counseling. Take a moment to subscribe to our mailing list to receive notification of newly published money management and investing articles.