Consolidation Loans

consolidation loansMany Americans now find themselves with multiple revolving debts: credit cards, non-mortgage loans, etc. My guess is that virtually all of them have at some point thought to themselves that it would be nice to consolidate each of those monthly payments into one loan so that they could get out of debt once and for all. Am I right? For some of you this may be a sound financial endeavor, assuming of course that your credit is still good enough to qualify for a loan. There are upsides and downsides to the issue that need be analyzed before taking a plunge.

Upsides to Consolidation Loans

  • Reduce many payments to just one payment.
  • You would likely, certainly if credit cards are involved, be borrowing at a lower overall interest rate.
  • Most likely, a consolidated loan payment at a lower interest rate would also most certainly be a lower payment than the sum of the previous payments freeing up valuable cash flow each month allowing you to live a little more comfortably.

You have to be careful however because there are downsides and potential traps to a consolidation loan.

consolidation loans

Downsides to Consolidation Loans

  • Longer finance period: most loans are in increments of 12 months so you may wind up extending the overall finance period allowing the loan institution to earn additional interest on the back end of the loan despite an overall lower rate. Not necessarily a bad thing, but do the math before signing the line.
  • Over-borrowing: You’re likely to have the option to borrow a bit more than you owe on your current debt. We could all use more money but be sure that whatever you use those funds for is worth not only the principle but also the additional interest over the life of the loan.
  • Subsequent credit card use – the biggest risk if you use a consolidation loan to absorb credit card payments is continuing to use the credit cards that are paid off by the loan. If you do this you’ll once again have the minimum credit card payment along with the loan payment and could ultimately wind up owing more and making higher monthly payments than you had to begin with.

I believe consolidation loans can be beneficial under certain circumstances. The trick is to change the behavior that led to the debt in the beginning. In The Total Money Makeover, Dave Ramsey teaches debtors to first save a $1,000 emergency fund before tackling their debt because he doesn’t want them to be faced with a shortfall one month and blow all the progress they’ve made until then. This is essentially the same issue so I encourage you to honestly assess your own financial practices and make adjustments so you come out the other side of the consolidation loan in better shape, not worse. The following books are excellent guides to making good financial decisions.

Stop Acting Rich The Richest Man in Babylon The Wealthy Barber Rich Dad Poor Dad
Thomas Stanley George Clason David Chilton Robert Kiyosaki


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