Debt Consolidations, Loan Offers, and 5 Important Questions

Michelle Tuvey Michelle Tuvey | Loan Underwriter

If you were to Google the question 'is debt consolidation a good idea', you would find multiple answers on both sides of the issue. The truth is that debt consolidation is good for some people in certain circumstances but bad for others in different circumstances. There is no way to make a blanket statement one way or the other. So how do you know? You start by thinking long and hard about debt consolidations, loan offers, and the five questions listed below.

1. What makes up the bulk of my debt?

One of the many advantages of debt consolidation is that, when done properly, it lowers the total amount of interest a person is paying. The point is to consolidate higher interest debts into a single loan with a lower rate. So, the first question to ask is what makes up the bulk of your debt.

If most of what you owe is on high-interest credit cards, you may be a good candidate for debt consolidation. Credit card interest rates can run anywhere from 7% to 19% or more. Debt consolidation loans structured as secured loans against property almost always offer significantly lower rates.

2. Can I pay off the debt in a reasonable amount of time?

Getting a lower interest rate by consolidating debts is a good thing. But there is another thing to consider: the amount of time it will take to pay off the debt. If you can pay off a consolidation loan in a reasonable amount of time, say 3 to 5 years, for example, you will still save money on interest. But if you were to stretch that loan out to 10 or 15 years, you may actually pay more in interest simply by extending the term. Then debt consolidation would not be such a wise idea.

3. Do I need a lower monthly payment?

Sometimes interest rates and terms are not the two most important factors for debt consolidation. Sometimes the simple matter of needing more money to pay your monthly bills is the priority. So your next question is whether you absolutely need a lower monthly payment.

Take a look at your budget. How are you doing? If your finances are taken to the brink of disaster every month, you have no room for emergencies or unforeseen expenses. In your case, debt consolidation would be a good idea if it could substantially lower your monthly outlay. It is better to pay more interest over the long term than face bankruptcy in the short term because you cannot pay monthly bills.

4. Can I freeze or reduce my spending?

The biggest reason some financial experts advise against debt consolidation is the habit among borrowers to keep spending at the same rate that got them into financial trouble. We cannot argue with that principle. That is why we suggest your next question be one of whether you can freeze or reduce your spending.

Debt consolidation can only accomplish what it's intended to accomplish if regular spending does not increase. Otherwise, the borrower continues to go deeper into debt. If you don't believe you can freeze or reduce your monthly spending, you might want to get some debt counselling before you apply for a consolidation loan.

5. Do I own property with sufficient equity?

Lastly, ask yourself whether you have sufficient equity in your property. Why? Because personal, unsecured loans do not make very good debt consolidation instruments. To do debt consolidation properly, you really need a secured loan taken against the equity in your home.

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