Debt Consolidation Loans Are Not For Everyone
Author: Roger SteinkyThe down and dirty tru th about debt consolidation loans is that they are not a good fit for every person dealing with massive debt. They are not the end all and be all of debt management and can actually end up increasing the amount of cash that you dole out to your creditors. Even though this is a cold, hard fact for some individuals debt consolidation loans can be a very helpful tool in the fight to get out of huge piles of unpaid bills by helping them reduce their debt payments to a manageable monthly payment.
The ability of debt consolidation loans to reduce the amount of you monthly payment is what is called in the financial world a "cash flow" fix. The problem with some people's debt is that it has risen to such a high percentage of their pay that they are finding it extremely difficult to keep up with their current level of expenses. Things like paying rent, getting groceries, and buying diapers for the kid are being put into jeopardy because you have to put so much of your hard earned cash toward monthly payments on this and that debt.
Debt consolidation can help solve this short term problem of not being able to meet your financial obligations by increasing the term of your loan and reducing your interest rates. The immediate result of this change is to reduce your monthly payments - sometimes dramatically.
The idea behind this is that with a reduced payment you will then be able to better handle the daily expenses of life, save some money for future expenses (thereby preventing you from having to go back into debt when something unexpected occurs), and get back to focusing on changing your lifestyle or spending habit to coincide with your financial reality.
There is, however, a price to be paid for those who choose this option. In the long term, you will most likely end up paying your creditors more money than if kept paying at your current rate. There is one main reason for this - debt consolidation often increases the term of your loan.
Why does increasing the term of a loan matter? Simply put, increasing the term of the loan also increases the amount of time that interest will be working against you. The more time interest works against you the more money you will end up paying to your creditors.
Let's look at an example to see how this works itself out in real life. For the sake of simplicity we will say that a person named Jack is seeking to take out a $1,000 debt consolidation loan. This is a pretty low number as far as most loans go, but for this example it will do just fine - it is a nice round number.
Jack has the choice with his debt consolidation company between the following two loans:
- a $1000 loan with a 6 year term and an interest rate of 5.25% (monthly payment of $16.22)
- a $100 loan with a 7 year term and an interest rate of 4.50% (monthly payment of $13.90)
Which of these choices should Jack make? Well, if we do the math we will see that both loans end up paying the same amount over the entire term of the loan - about $1,167. One must be very careful that the reduction in interest rate they receive is worth the extra time that is added on to the term of loan.
If the term on the second loan had been increased by just one more year, the monthly payment would have dropped further to $12.42 - but the amount of interest paid back to Jack's creditors would have risen by 15%. That is a lot of money.
Debt consolidation should never be seen as the fix all for every debt situation. It has its place as a quality debt management tool given the right circumstances and the right execution, but it is definitely not for everyone. The truth about debt consolidation is use it wisely or get burned by it badly.
About The Author:
Roger provides basic tips for those just beginning to see if
debt consolidation is going to be right for their situation. You
can find his blog on the topic at Deb
t Consolidation For Beginners.
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