Before Getting a Debt Consolidation Loan, Ask Yourself These 3 Questions

For consumers carrying a large debt load, life can be a very stressful experience. Managing payments and dealing with creditors is difficult when you are barely keeping your head above water and having trouble making ends meet. Consumers can get into a vicious cycle of cash shortfalls and continuing to use credit cards just to make it through the month. When they approach the brink of insolvency, they begin to look for solutions to deal with their oppressive debt.

Many consumers, in fact millions, are carrying debt loads that are too much for them to handle. Much of the debt they are carrying is credit card debt. As of the end of the first quarter of 2017, Americans reached an all-time high in their levels of consumer debt. A recent article in the New York Times noted that household debt surpassed the previous high-water mark reached at the beginning of the financial crisis of 2008.

With household debt soaring to new heights, many consumers are considering debt consolidation loans as a means to manage their oppressive debt. While debt consolidation can be a viable means to managing one's debt, there are certain pros and cons to consider and questions every consumer should ask before taking that path.

However, before we cover those questions, let's take a deeper dive into debt consolidation loans.

What is a debt consolidation loan?

Debt consolidation loans help consumers by combining all their debts into one loan that has a single payment. The hope is that the interest rate will be substantially lower than what the consumer has been paying on individual credit cards. This likely would mean that the new payment would also be substantially less than the sum total of the consolidated payments. In addition, making just one payment per month instead of many streamlines the process and takes some of the strain of the debt burden off.

By reducing the outflow of cash, the consumer has a chance to get on top off his or her debt problem or put more money towards paying off the debt. Debt consolidation loans come in several forms, and choosing the right one is an important step in resolving one's debt. Give careful consideration to details of the consumer's individual circumstances such as how much the individual needs to borrow and his or her current credit score.

Many consumers who are homeowners look to utilize the equity in their homes to address their debt problem. This is only possible, of course, if the consumer owes substantially less on the mortgage than the home is worth. Many times, this equity comes via a Home Equity Line of Credit, or a HELOC. If the borrower receives approval for the line of credit, he or she is free to use the funds in any manner, so it's a suitable way for consumers to consolidate their debt. HELOCs usually require the borrower to have a large amount of equity in the home, have a good credit score, and be able to show a verifiable source of income.

Other borrowers will choose to utilize the equity in their home by refinancing their mortgage and taking additional cash out to pay off their debts. The consumer borrows more money than the current home mortgage balance and uses the excess to consolidate credit card debt into the mortgage. As with a HELOC, for a consumer to qualify for a home refinance, he or she would need a favorable credit score, adequate equity, and verifiable income.

For consumers who have credit card balances that are relatively small, a personal loan might be a viable option. Banks and finance companies usually extend these loans to consumers who have decent credit scores and a low amount of debt. Interest rates on personal loans are usually less than what credit card companies charge, but the term of the loan is usually relatively short, compared to mortgage loans. Many consumers take out these loans to get their credit card debt paid off quickly.

The upside to debt consolidation loans

Debt consolidation loans can help consumers get on top of their debt problem. Consumers should consider some of the advantages of consolidating debt.

Just one payment

For many consumers, one of the more attractive things about obtaining a debt consolidation loan is taking all of their debts payments and combining them into one payment. Having just one payment to make each month helps consumers stay organized and avoid missed and late payments.

Reduced payments

Most consumers consolidate their credit card debt to reduce the amount of money they are paying out each month. If they are able to get a much lower interest rate, they could see substantially lower payments, depending on the length of the terms. This could help consumers save money for emergencies or put more money toward their debt each month.

Lower interest rates

Debt consolidation loans such as mortgage refinances, HELOCs, and personal loans will nearly always carry a lower interest rate compared to credit cards. This will result in lower payments that can help a consumer be better able to make ends meet and stop living paycheck to paycheck. In fact, if they save enough money each month, consumers may be able to begin saving money as a protective measure against financial emergencies, such as medical bills, expensive car repairs, or even job loss.

Get caught up

For consumers who have been struggling to keep up their payments, or are behind in their payments, a debt consolidation loan can be a breath of fresh air. With all their credit cards accounts paid off, and their debts consolidated into one, they can focus on getting their financial lives back on track and stop worrying about late or missed payments.

Moreover, if their new, lower payment allows them to open a savings account, they may be able to create some financial security for their family instead of depending on credit cards to make ends meet.

The downside of debt consolidation loans

Debt consolidation loans carry some significant advantages for consumers who utilize them to address an oppressive debt problem. However, some potential drawbacks to debt consolidation loans are of note for consumers to be aware of when considering a consolidation loan.

Some consumers may be at risk of accumulating credit card debt again

Consumers that do the hard work and maintain the self-discipline to pay off their credit cards one painful payment at a time learn valuable lessons about money management. Because of this, they are much less likely to fall back into debt than those who have utilized a debt consolidation loan to address their debt problem.

Debt consolidation, especially mortgage-based consolidation loans, tend to “sweep debt under the rug” for many consumers. The process is just too easy. The danger of this is that, by not going through the difficult process of paying off debt through hard work, the consumer could end up accumulating more debt on top of an already bigger mortgage. If this happens to a large degree, a consumer could potentially put his or her home in danger of foreclosure if unable to meet their obligations.

Consumers may pay more interest over the life of the loan

Rolling debt into a mortgage loan could mean that, even with a lower interest rate, consumers could end up paying more interest in the end. This is because mortgage loans have much longer loan terms. Mortgage loan terms can vary, but most are 30 years. Consumers should put a calculator to the numbers to make sure that consolidating debts into the mortgage makes sense.

Consumers may not change their spending practices

Many consumers do not change the way they manage their money after consolidating their credit card debts. If this is the case, they can find that not much changes for them after debt consolidation. Many times, the extra cash flow created with debt consolidation is eaten by poor spending habits. Therefore, consumers may find themselves relying on credit cards once again to get through the month.

Three questions to ask before you get a debt consolidation loan

Before making the leap to consolidate credit card and other debt, ask yourself three questions to make sure you are making the best possible financial decision.

1. Have I made the necessary lifestyle changes to make debt consolidation successful for me?

It is important to recognize the circumstances that put you into debt in the first place. If you have been overspending and being irresponsible with money, this will need to change for debt consolidation to work. If you continue to live above your means and start relying on credit cards to make ends meet, you will soon find yourself back in debt again.

If your problem has arisen from circumstances beyond your control, such as an unexpected illness or injury or the loss of a job, make sure your situation has improved and that you will be able to meet your obligations going forward. A debt consolidation loan can only make your financial situation worse if you continue to rack up debt in addition to your new loan.

2. Have I chosen the right type of loan for my circumstances?

As mentioned above, several types of debt consolidation loans exist for consumers to consider. It is important to remember that bundling your debts into your home mortgage comes with some risk. If you are unable to meet your larger mortgage payment, you could be putting your largest asset at risk. Losing your home to foreclosure is a monumental, catastrophic event, so be sure you are not inviting that risk with a new debt consolidation loan.

If your debts are not too large, and you are looking to pay them off quickly and efficiently, then you may consider a personal loan. Personal loans can be a good choice for those consumers who have good credit and relatively small credit cards balances.

3. Are there other options available to me other than a debt consolidation loan?

Debt consolidation can be a good option for many consumers, but for those who've had money issues for some time, qualifying for a loan may come with considerable challenges. If you are willing to put in the hard work and remain diligent about paying off your credit card debt, you could potentially handle your credit card debt repayment on your own.

DIY debt management

Those who have the self-discipline to take on a DIY debt management strategy have a couple of options to consider. One is to simply look at your statement and determine, from the information on the front page, what payments are necessary to pay off your balance in three years. All credit cards companies must provide you with this information on their statements. Then, you simply pay that amount, every month without fail (for every card), and you will be free from credit card debt in 36 months.

Or, you could utilize the “snowball method” where you start with the lowest balance first, pay as much as you can on it every month, and just pay the minimum on everything else. Once the lowest is at $0, you move to the next, and so on, until all debts are gone.

Consumers who are unable to make any progress with their debt on their own and are unable to qualify for a debt consolidation loan might consider working with a debt management company. National Debt Relief works with consumers to settle their debts with creditors by negotiating a lump sum settlement. While the process isn't fast, it's far better than declaring bankruptcy.

Getting on top of a burdensome debt load can be difficult for many consumers. It's important to remember that acting before options become few is imperative. Take the first step today and get your debt under control so you can get back on the road to financial peace.