Debt Consolidation:The great saviour?Debt consolidation means combining several loans with very different interest rates into one low payment, usually based on your home loan. Sounds good – going from over 20% interest on your credit card to the lowest rate you can usually find which is your home loan interest rate. It could release a lot of cashflow for you every month which could be a huge help when times are tough. What’s the problem?
1. It’s when you really need it that you are least likely to get it – or get it on decent terms, anyway. If you really need a consolidation loan, chances are that you are over-extended and your credit history is less than perfect. This reflects badly on your credit record and makes it less likely that you will get a loan at a good interest rate.
If you have a house, and the market value is higher than the outstanding bond amount, then you can get a consolidation loan from someone less well known than the usual banks. Chances are you will pay more in interest – something like 5% above prime, maybe more. Does this still make it worth it? You do the sums.
The highlighted bits are the stumbling blocks.
If you are lucky you can get a consolidation loan from someone fairly responsible who will not charge outrageous interest rates and who might even help you run the loan, doing things like eliminating expensive retail debt and credit cards first, helping you escape harassment from creditors, etc. If you’re lucky. But often desperate people are drawn to this lifeline and they of course fall prey to the usual array of vultures.
2. Another catch – your total monthly debt will probably come down and if it does, that extra money should go only to repaying the debt but often doesn’t.
The temptation is there for people to spend it – to run up more debt. Then it’s like the dual income trap – you’ve used up your last chance, and now there are no more options.
3. In the long run it costs you more because you are repaying your shorter term loans over 20 years.
But if you use the extra cashflow it releases to repay your debt faster, then it is something that can work for you IF the interest rate you are offered really makes sense – and you can only tell if you do the sums.
4. And don’t forget, there will be fees to pay, attorneys’ fees, bond fees, etc.
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