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Pros and Cons of Debt Consolidation

Pros & Cons of Debt ConsolidationEvery important decision in life should be preceded by thoughtful consideration. If you’re dealing with overwhelming debt, a debt consolidation loan is one of those decisions.
Debt consolidation is the process of combining short-term unsecured debt (credit cards, personal loans, etc.) into one, long-term, secured loan payment. Instead of paying seperate bills to each of your creditors, a single payment is paid to a debt consolidation or credit counseling company, who in turn makes payments to creditors on your behalf. Although debt consolidation may not be right for everyone, here are the pros and cons to help you decide if it’s right for you: 

The Pros of Debt Consolidation

  • Peace of Mind – Perhaps the most unappreciated benefit of consolidating your debt is the relief that comes with a manageable monthly payment.
  • Simpler Debt Management – Manage a single, predictable loan payment, simplifying your finances.
  • Lower Interest Rates – Debt consolidation loans typically have lower interest rates than credit cards and other unsecured debt. A drop of a few percentage points can help free up funds that can be applied torwards savings, further debt reduction or a retirement account.
  • Reduction in Monthly Payments – Due to lower interest rates and the fact that debt consolidation is spread out over a longer period of time, monthly payments are usually significantly lower.
  • No More Late Fees – Getting charged for a late payment fee is frusterating for anyone. With a debt consolidation loan, there is only one payment to worry about – the debt consolidation payment.
  • Accounts Closed – When a creditor agrees to consolidate, they will require the account to be closed until the balance is paid off. Although this might seem like a negative, anything that will prevent more debt is a good thing. Plus, it will teach you to rely more upon your income and less upon credit.

The Cons of Debt Consolidation

  • Good Credit (and Collateral) Required – Just like any loan, your credit history will be a factor in getting approved for a debt consolidation plan. And since a debt consolidation loan is “secured”, you’ll need collateral in the form of home equity (or other assets).
  • Risk of a Secured Loan – Personal loans and credit cards are unsecured, but debt consolidation requires collateral, typically your home. This puts your home at risk, if you fail to keep up repayments.
  • Difficulty in Securing New Credit – Even though it could make it even harder to get out of debt, there are times when a new credit account may be necessary. Although debt consolidation won’t severely impact on your credit score in the long-term, it could make it more difficult to secure new lines of credit during, or shortly after you consolidate your debt balances.
  • Higher Total Interest – With a longer term loan, the total interest paid over the life of the debt will be higher.

The advantage of having only one monthly payment, especially for those who’ve had with problems juggling multiple payments in the past, cannot be overstated. And a lower monthly payment can make a huge difference as well. Although there might be a short-term negative impact on your credit score, debt consolidation could help you get you back on track in a reasonable amount of time. If you have good credit and equity in your home, consider the pros and cons of debt consolidation. It could make the difference between bankruptcy — and financial independence.

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