If you find yourself
struggling with your payments on loans, store and credit cards, there's a much easier way
to pay. Debt Consolidation, where all your outstanding debts are rolled up into
one debt and you pay just one lender.
Debt consolidation is an easy
way to take the strain out of your finances and reduce your monthly outgoings. Loans on
credit and store cards can be at high interest rates and should only really be used for
very short term borrowing. If you are heavily in debt with one or more companies then you
should seriously consider consolidating your debts.
Debt consolidation, more often
than not, involves a secured loan against an asset, usually property. An unsecured loan
can also be obtained, however, interest rates will be considerably higher due to the
additional risk the lender takes.
Shop around and find the best deal,
remember, debt consolidation is offered by many lenders and fierce competition is
seeing some good deals on offer. It will pay to take your time and strike the best deal
you can. A debt consolidation deal may span many years and small differences in
the interest rate can make a large difference in the total payments made. |
Debt Consolidation -
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Debt consolidation entails taking out one loan to pay off
many others. This is often done to secure a lower interest rate, secure a fixed interest
rate or for the convenience of servicing only one loan.
Debt consolidation can simply be from a number of unsecured loans into another unsecured
loan, but more often it involves a secured loan against an asset that serves as
collateral, most commonly a house. In this case, a mortgage is secured against the house.
The collateralization of the loan allows a lower interest rate than without it, because by
collateralizing, the asset owner agrees to allow the forced sale (foreclosure) of the
asset to pay back the loan. The risk to the lender is reduced so the interest rate offered
is lower.
Sometimes, debt consolidation companies can discount the amount of the loan. When the
debtor is in danger of bankruptcy, the debt consolidator will buy the loan at a discount.
A prudent debtor can shop around for consolidators who will pass along some of the
savings. Consolidation can affect the ability of the debtor to discharge debts in
bankruptcy, so the decision to consolidate must be weighed carefully.
Debt consolidation is often advisable in theory when someone is paying credit card debt.
Credit cards can carry a much larger interest rate than even an unsecured loan from a
bank. Debtors with property such as a home or car may get a lower rate through a secured
loan using their property as collateral. Then the total interest and the total cash flow
paid towards the debt is lower allowing the debt to be paid off sooner, incurring less
interest. In practice, many people are in credit card debt because they spend more than
their income. If that habit continues, the consolidation will not benefit them much
because they will simply increase their credit card balances again.
Because of the theoretical advantage that debt consolidation offers a consumer that has
high interest debt balances, companies can take advantage of that benefit of refinancing
to charge very high fees in the debt consolidation loan. Sometimes these fees are near the
state maximum for mortgage fees. In addition, some unscrupulous companies will knowingly
wait until a client has backed themselves into a corner and must refinance in order to
consolidate and pay off bills that they are behind on the payments. If the client does not
refinance they may lose their house, so they are willing to pay any allowable fee to
complete the debt consolidation. In some cases the situation is that the client does not
have enough time to shop for another lender with lower fees and may not even be fully
aware of them. This practice is known as predatory lending. Certainly many, if not most,
debt consolidation transactions do not involve predatory lending.
Student loan consolidation
In the United States, federal student loans are
consolidated somewhat differently, as federal student loans are guaranteed by the U.S.
government. In a federal student loan consolidation, existing loans are purchased and
closed by a loan consolidation company or by the Department of Education (depending on
what type of federal student loan the borrower holds). Interest rates for the
consolidation are based on that year's student loan rate, which is in turn based on the
91-day Treasury bill rate at the last auction in May of each calendar year.[citation
needed]
Student loan rates can fluctuate from the current low of 4.70% to a maximum of 8.25% for
federal Stafford loans, 9% for PLUS loans.[citation needed] The current consolidation
program allows students to consolidate once with a private lender, and reconsolidate again
only with the Department of Education.[citation needed] Upon consolidation, a fixed
interest rate is set based on the then-current interest rate. Reconsolidating does not
change that rate. If the student combines loans of different types and rates into one new
consolidation loan, a weighted average calculation will establish the appropriate rate
based on the then-current interest rates of the different loans being consolidated
together.
Federal student loan consolidation is often referred to as refinancing, which is incorrect
because the loan rates are not changed, merely locked in. Unlike private sector debt
consolidation, student loan consolidation does not incur any fees for the borrower;
private companies make money on student loan consolidation by reaping subsidies from the
federal government.
Student loan consolidation can be beneficial to students' credit rating, but it's
important to note that not all federal student loan consolidation companies report their
loans to all credit bureaus.[citation needed]
Concerns of consolidation
In recent years, reports in the media have raised concerns
about the use of consolidation loans.[1] The worry is that many people are tempted to
consolidate unsecured debt into secured debt, usually secured against their home. Although
the monthly payments can often be lower, the total amount repaid is often significantly
higher due to the long period of the loan. Debt consolidation sometimes only treats the
symptoms of debt and does not address the root problem. In some circumstances, snowballing
debt may be a better solution.
There are other alternatives to a debt consolidation loan, where unsecured debt is not
"shifted" to secured debt, but is eliminated through a settlement or payment
plan. Debt consolidation can be confusing for many people, so it is helpful to learn about
all of your options, and sometimes with the help of an advisor.
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