Are Debt Consolidation Loans Costing You More Than You Expect?
Debt consolidation loans are promoted as offering people a positive way to reduce debt and save money at the same time. The principle is to roll all your balances into one convenient loan. Your old credit cards and personal loans are closed, so you only have one easy monthly repayment to think about for your new consolidation loan.
For many people, the convenience of only having one loan payment each month is welcomed. It’s much easier to remember when payments are due. You’re also less likely to be past due with your accounts with a single monthly payment than you would with multiple due dates to remember each month.
On the surface, debt consolidation loans can seem like a great idea. In fact, they can be a good option for many people, especially if you have excellent credit and obtain a low interest rate. You can take advantage of paying less interest on your debt balances each month.
Unfortunately, there are times when some debt consolidation loans could put you in a worse position than you were in the beginning. If you’re not careful, it could end up costing you more to pay off your debt than if you’d done nothing at all.
The key to choosing the right option for your situation is to understand the type of consolidation loan you’re getting. It’s also a good idea to work through some comparison calculations to be sure you’re not paying more than you need to.
Secured versus Unsecured Debt
An unsecured loan doesn’t take use any of your assets as collateral for your debt. For example, a credit card is unsecured, as you have access to credit without using your car or your home as security collateral. In the event that you can’t make your repayments, the lender can’t repossess your assets to repay your debt.
It’s also worth noting that some unsecured consolidation loans can come with interest rates in excess of 20%. The high interest charges could translate to increased monthly costs out of your pocket overall.
By comparison, secured loans require that you use an asset as collateral security for your debt. Your creditors also have access to your assets in the event of a default.
Secured loans are usually offered at a lower interest rate than their unsecured counterparts, making them seem more appealing. However, the really cheap interest rates are reserved for customers with excellent credit. If your credit score is impaired you may find you’re paying a much higher interest rate than you expected, even with a secured loan.
Comparing Your Options
The easiest way to know whether a debt consolidation loan is right for your individual financial situation is to compare the total costs. There are plenty of good loan comparison calculators available online that let you input your debt balances, interest rates and any other associated fees you’re charged.
For example, let’s assume you have a total of $22,000 in credit card balances, store cards, student loans and personal loans you want to consolidate. Your current minimum monthly payments add up to $516. However, keep in mind that you’re only paying the minimum amounts due.
|Debt Type||Current Balance||Minimum Monthly Repayment|
|Credit Card 1||$5,000||$150|
|Credit Card 2||$2,000||$60|
Now let’s look at what happens if you apply for an unsecured debt consolidation loan. If the lender charges you 17% interest over a loan term of 5 years, your repayments will be $547 per month.
You end up paying more money out of your pocket each month just to cover your repayments. However, each payment you make actively reduces your debt levels, so you’ll be debt free in 5 years. If you’re already struggling to repay your debt balances, paying more money each month could put a drain on your budget.
Of course, there’s also the total cost to consider. At repayments of $547 per month over a term of 5 years, the total amount you’ll repay to the lender is $32,805. That’s $10,205 more than the original amount you borrowed.
Alternatives to Debt Consolidation Loans
Another alternative is to consider a debt settlement arrangement. Many banks, financial institutions and lenders will happily enter a settlement agreement for a reduced debt balance in the hopes of getting some of their money back from you.
Before you agree to any debt consolidation loans or offers, take the time to discuss your financial situation with a debt settlement specialist. You could reduce your monthly repayments, making your budget easier to manage. You could also end up repaying far less than you thought, but the only real way to know is to compare your options accurately before you make a decision.