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Is Debt Consolidation A Good Idea?

Here are the pros and cons of debt consolidation loans.

If you are even considering the idea then you may already be in financial trouble and debt consolidation may help make life easier. The downside is that you will be paying off what should have been short term bills, for many years to come.

How Debt Consolidation Works.

There are a couple of ways to consolidate debt. One is through a credit card transfer.

If you are approved for a lower rate credit card you may transfer the balances of your higher rate cards to that one card and pay less interest. You have to watch the fine print though since some of these offers go up after the first year. If you are already in financial trouble it is unlikely your credit score will be high enough to get a super low rate on a credit card that would make a balance transfer worthwhile. That leaves you with one other option...

The Benefits Of Home Equity Debt Consolidation Loans

Another method is through a loan against the equity in your home. This is your home and shelter you are going to be borrowing against so make sure you understand what you are getting into.

If the choice is between bankruptcy and a debt consolidation loan then you are probably better off consolidating.

How debt consolidation works is that, provided you have enough equity in your home you would take all of your bills including student loans, credit cards, store cards, gas cards and so on which have high interest rates and refinance the total amount over a longer period of time at a lower interest rate. Say for example the interest rate you are paying on your credit cards is 19% and you are only making the minimum payment. It may take you 15 years to pay off the balance at that rate and you will pay many times over the amount you initially charged on your credit card.

Now if you take that same credit card balance and lump it in with the rest of your debt at a rate of say, 8% over 15 years then you will pay a lot less interest  and pay off more of the principal faster.

If you can take this option before you get into serious financial trouble you may get a favorable rate from your home mortgage company. However if you wait until you get into serious financial trouble and are forced to go through a debt consolidation company for such a loan you may pay higher interest rates and negatively affect your credit rating.

Debt consolidation loans are a good idea if you are facing hard times. If you have substantial home equity can be a good way to stay out of bankruptcy. A bankruptcy will last at least seven years and you will have to pay much higher interest rates on car loans and may not qualify for a home loan until it clears. Your bankruptcy, although it may seem like an easy way out, will cost you dearly in the long run.

A debt consolidation loan, if used properly can get your bills down to manageable levels that you can pay on time and restore or preserve your good credit rating.

The Negative Aspect Of Debt Consolidation

Where many thousands of Americans go wrong with debt consolidation loans is that they reduce their monthly bills only to get new ones to replace them and repeat the cycle of spending tomorrow's money today. It can be a serious temptation if you have spending habits that you have developed over time and  then are suddenly given lower bills and more money left over at the end of the month. You may take on new spending habits or finance new purchases with that money instead of rebuilding your nest egg. Once you start doing this you have lost any chance of regaining the equity in your home that you worked so hard for.

The way to avoid that trap is after debt consolidation, to discipline yourself into paying any extra money that you have left over at the end of the month against your mortgage / debt consolidation loan. Most loan companies will not penalize you for paying extra principal but make sure to check that they don't penalize before entering into a loan.

For debt consolidation to work you must learn from past mistakes and then take the second chance you are given to feed the piggy bank and get your nest egg back in shape. You don't want to be 65 and still have a thirty year mortgage. Your goal should be to have your home paid off by that age so that your social security and retirement income can go to other things besides a mortgage. By Karen Yates, Tax Preparation Specialist For H&R Block.  The opinions expressed in this article are my own should not be considered financial advice.

Knowing your FICO score is very important before you start shopping around for a refinance, or for a new home. The only company that provides your FICO score as used by mortgage companies, from all three bureaus is MyFico.





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