A debt consolidation loan is a loan you get to pay off other debts. If you owe balances on three different credit cards, a debt consolidation loan combines all of your credit card balances into one loan, so you only have one monthly payment. That’s great if it reduces the interest you pay, because it will save you money.
But beware of these three common debt consolidation loan traps.
Debt Consolidation Trap 1
If you pay off your credit card debt, stop using your credit cards! If you will be tempted to use your credit cards to start building up your balance again, you will be stuck with more debt: your debt consolidation loan, and your new balances on your credit cards. That’s the trap.
So, if you get a debt consolidation loan, pay off your credit cards, and then cut them up, so you can’t spend any more money.
Debt Consolidation Trap 2
The most common example of a ‘good’ debt consolidation loan would be getting a loan or line of credit from your bank at a 6% interest rate to repay the outstanding balances on your credit cards that carry a 20% interest rate. Your total debt remains the same, but you are paying less in interest, so you can repay your debts faster.
However, a debt consolidation loan does not reduce your debt, it just replaces one type of debt with another type of debt. If you lower your monthly payment just because your interest dropped, you run the risk that you will never actually lower your balances and won’t get out of debt.
Debt Consolidation Trap 3
To obtain a debt consolidation loan you have to qualify. This may require you to put up collateral as security like your car or home equity. If you’re new loan doesn’t solve your underlying financial problems you may find yourself in default on your new, secured debt consolidation loan putting your assets at risk.
Consider your options carefully before getting a debt consolidation loan. Use our debt options calculator to examine your options before getting a consolidation loan.
Better yet, get free objective advice about your personal situation. Contact an advisor today for help.