What are the Advantages and Disadvantages of a Debt Consolidation Loan?

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When you are swimming in debt, a debt consolidation program may sound like a dream come true. However, there are certain pitfalls to be aware of before signing on for one of these programs. We’ll teach why debt consolidation is a bad idea for some and a valid option for others.

How Do Debt Consolidation Programs Work?

So how does a debt consolidation program work to help you reduce your debt? You apply for and secure a loan, and use that money to pay your current creditors. Then you make monthly payments on the new loan itself. Debt relief companies can assist in securing the loan, or it can be done through a bank or as a home equity loan. Debt relief companies can contact your credit card companies on your behalf to try to consolidate your debts and roll them into one payment with a lower interest rate. You then pay the debt relief company, and they make the payments to your creditors. But this can actually end up costing you more in the long run, as you will most likely take longer to pay off your debt and potentially spend more on interest overall.

Disadvantages of Debt Consolidation

Aside from potentially higher interest rates and paying more in the long run, debt consolidation loans could also negatively affect your credit score. When you apply for a new credit loan, an inquiry is made on your credit report, and your credit score can take a fall. You want to ensure that you calculate all the interest on your current accounts and compare that against what the consolidation program is offering you, to see if it is a better choice overall.

Additional Risks

U.S. News notes that there is “no guarantee” that your interest rate will be lower with a debt consolidation program. Everything depends on your credit score and past payment behavior and is at the mercy of the lender. Also, even if you start with a lower interest rate, there is no guarantee that it will stay that way. Usually, you can find a low introductory rate, but it may change and increase over time. You will often secure a lower rate, but the loan term is often extended, meaning you will actually be paying more in interest over the long term. What really needs to happen is changes in your spending behavior, and establishing money habits that help you eliminate your debt and not have it return.

Alternatives to Getting Free of Debt

Debt consolidation programs can cost you more in the long run. Often, the debt consolidation company wraps the cost of their services up in your monthly payment so that you never see the direct charges, and you pay more than if you had just handled it yourself, per U.S. News. It is important to note that you are able to contact your lenders and credit card companies directly to work out a lower interest rate or reasonable payment program.

The Real Solution

Treating the actual reasons behind your money problems is the real solution in debt relief, says Dave Ramsey, founder of Ramsey Solutions. You have to solve those problems first so that you don’t find yourself in the same situation again. Change the way you look at money, purchases and needs vs. wants. That is the only way to get out of debt, secure your financial future and live a fiscally healthy life.

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