Debt Consolidation Loans

A debt consolidation loan is often the best choice for consumers who have a lot of debt but are still financially sound. In fact, a debt consolidation loan may save a consumer money if most of their debt is high-interest. 

However, if a person is suffering from financial hardships a debt consolidation loan may actually worsen the problem. The reason for this is that it's difficult for a person with financial hardships to get a low interest rate unless they have perfect credit or very good collateral. Neither of which is usually the case. You must remember that a debt consolidation loan simply "transfers" the debt to a new lender and may not even lower a consumer's overall interest rate. 

If a person's who's having financial hardships is able to get a debt consolidation loan with a lower overall interest rate then this would be the right way to go. Another instance in which a person who's not financially sound may benefit from a debt consolidation loan is if they have past due accounts that are costing them in late fees and other punitive charges. Even a loan with a higher interest rate could help by eliminating these extra charges. In any case, it's important that the consumer is sure that they can meet all of the payments as scheduled.

Another important point is that debt consolidation loans are generally "secured". This means that if a consumer defaults on the loan, repossession, foreclosure, or other legal is very likely. In fact, lenders who make debt consolidation loans are often quicker to go after people who fail to meet their contract than many other types of lenders.

The most interesting point here is that many people consolidate unsecured debts into secured debts. While lenders do have legal recourse with unsecured debts, they generally are slow to follow up on them. This is because of the added hassle involved with the legal process. However, there is no such problem with secured debts - they already have permission to foreclose on property if you don't satisfy the terms of the contract.

Also, after a debt consolidation loan the consumer is faced with one large payment to one creditor rather than smaller payments to various creditors. In many cases this is beneficial but if the consumer is even one dollar short on a payment, the account may be considered in default. This won't usually result in legal action but late fees and penalties do apply. These added costs may cause the borrower to get further and further behind, which in the end will result in legal action and foreclosure. With payments to different companies, there are more options. For instance, the borrower could choose to miss a payment to an account that's unsecured and that has a lower late fee than the others.

Most debt consolidation loans are nothing more than home equity loans; however, that is not always the case. Both home equity loans and second mortgages use the equity in your home as collateral. The consumer typically gets a "line of credit" with a home equity loan. In this case it's only when money is drawn out of it that interest is charge on the amount taken out and payments begin. However, a second mortgage typically gives a "lump sum" and then immediately begins to charge interest on the whole amount. Both of these loans typically require processing fees, appraisal fees, and possibly other costs.

In the case of home equity loans or second mortgages the problem that debtors face most is not having enough equity in the first place. Most lenders use a formula that's based on a percentage of your home's current market value minus the amount still owed on it. Often by the time this is worked out and the processing fees and other costs are figured in the amount comes to less than the amount needed to pay of the other debts.

One advantage of a home equity loan or second mortgage is that the interest is tax deductible. With this in mind, consumers should seek the advice of an accountant to see if the tax break may help their decision.

Keep in mind that all the same pitfalls that applied to debt consolidation loans apply to second mortgages and home equity loans too. They are still just ways to shift debt from one creditor to another and still result in one large payment to one creditor.

Using a home equity loan to help accomplish a Debt Reduction Settlement may be a very good idea. In this case, a negotiator helps you reach a settlement with your creditors in which they agree to accept a settlement for less than the full amount. Typically the settlement must be paid in a lump, cash payment. This is often hard to come up with unless you get it through a home equity loan.

Debt consolidation loans are not for everyone but they can help reduce interest rates and offer the ease of making only one payment a month. Overall, this type of debt consolidation is recommended for people who have had hardships in the past but are starting to pull out of it. If you are certain you can meet the payments, then this is definitely something you should look into. If, however, you are still experiencing financial difficulties - you may want to look into credit counseling or a debt management program instead.