Debt Consolidation Loans Aren’t For Everyone

Countless Americans are drowning in debt.  According to the Federal Reserve as of July, outstanding consumer debt stood at $3.24 trillion with total outstanding revolving debt coming in at $880.5 billion.

For people struggling to pay down their liabilities a debt consolidation loan may seem like a viable option. After all it enables you to make one payment instead of spreading it around each month. But buyer beware when going this route. Not all consolidation loans are created equal which is why reading the fine print matters a lot.

Debt consolidation loans “don’t always make sense and the fine print should be closely examined on a case-by-case basis,” says Ken Lin, chief executive and chief consumer advocate for Credit Karma www.creditkarma.com. “Keep in mind that as with credit cards, financial institutions are looking to make money on loans.”

According to experts, before applying for a debt consolidation loan, whether it’s through a bank or other financial institution, you have to do the math to make sure you are getting a good deal. When comparing the details of the new loan with the terms of your existing debt Thomas Duffany, grant program director at the Association for Financial Counseling and Planning Education or AFCPE says you want to look at the interest rate, total interest paid over the life of the loan, monthly payment amount and any fees associated with the new loan. The term of the loan also matters. It may be that you are getting a lower interest rate but the length of the loan may make it costlier than paying off your individual debt on your own.

“While making only one payment per month may seem more appealing than making payments to your various credit cards, you should only consider a consolidation loan if you aren’t paying a premium for that convenience,” says Lin. He says to make sure you are borrowing from a legitimate bank and that you avoid paying any up-front fees to secure the loan. “As a general rule, when it comes to borrowing, if it seems too good to be true, it probably is,” says Lin.

When it comes to comparing the different debt consolidation offers available to you some of the costs you want to look at include application fees, origination fees and transfer fees. Duffany says to go with a loan that has a fixed interest rate instead of a variable one and one that specifies the length of the loan. If you are consolidating your debt via a credit card balance transfer make sure you know how long the introductory rate lasts and what the interest rate will be after the grace period is over.  Duffany says the balance transfer with an introduction rate isn’t the best option for consolidating debt, largely because if you don’t pay it off within a certain period of time you could be right back to where you started with a high interest rate loan. He also says it’s also a good idea to avoid secured loans. “Many people will use the equity in their home to consolidate credit card and other debts because they are often able to get very low interest rates,” he says.  “I don’t recommend this strategy as you would be replacing an unsecured debt with a secured debt putting yourself in risk of losing the house if you are unable to pay back the loan.”

In addition to choosing the right loan, you have to consider your personality. It may feel good to consolidate your credit card debt into one loan but if you end up charging up new debt than you’ll be in a deeper hole than when you started out. That’s why experts say before you apply for a consolidation loan take a realistic look at your debt and your spending habits and develop a plan to cut back some of your excess spending. You should also stop using your credit cards and not apply for new ones. “Debt consolidation can be helpful, but it's not a substitute for responsible spending,” says Charles Tran, founder of CreditDonkey www.creditdonkey.com.