What is a Debt Consolidation Loan?

There may be a number of reasons that you have thought about a debt consolidation. If you don’t understand their purpose or what they entail, you could end up making the wrong decision – a decision that could cost you thousands. Taking time to educate yourself, however, can help you make a well-informed decision.

How Debt Consolidation Loans Work

Applying for a debt consolidation means that you will be applying for a new loan. Your new lender will purchase your old loan or loans and offer you a new loan term and a new payment agreement. You will then have only one monthly payment with one lender instead of several loans with several lenders.

Why People Choose Debt Consolidation Loans

Having numerous loans can seem like a big hassle. There are a lot of different due dates to keep up with, different terms to consider. Most people choose debt consolidation loans because they seem like an easier method for handling their debts. This can be especially true if the individual is behind on their loans or feels like they can no longer manage all of their payments. Unfortunately, this assumption is not always true.

The Truth About Debt Consolidation Loans

Often your lender can purchase your old loans at a lower price. This is not always the case. Even if they are able to purchase it at a lower rate, you may have a higher interest rate. This can be especially true if you have had any late payments or new credit blemishes since you took out your original loans. You may even have early pay-off fees with your old lenders included in your loan with your new lender. So, while it may seem that debt consolidation loans will save you money, you usually end up paying the same amount and, in some very unfortunate cases, you may end up paying more.

Another thing that isn’t always shared with individuals when they apply for a debt consolidation loan is that debt consolidation loans can actually damage your credit. Credit bureaus look at a variety of factors when determine your credit rating. When you close several accounts, it can have a negative impact on your credit in the short term and, in some cases, the long term. If you make your new payments on time, you can recover your credit score with time but always remember that credit score is actually based your ability to manage credit.

When is a Debt Consolidation Loan a Good Idea?

A debt consolidation loan is not a bad idea for everyone. There are some cases, like the potential of foreclosure or bankruptcy, in which debt consolidation is a better option. Carefully evaluating your situation and determining whether or not there is another way to manage your debt problems can sometimes help you avoid a poor credit decision like a debt consolidation loan. If, however, there are no other options, then a debt consolidation might be right for you.

The Importance of Smart Shopping

You should never accept a debt consolidation loan from the very first company you talk to. You should take the time to check with as many debt consolidation institutions as you possibly can. You can find debt consolidation options on the internet, at banks, through credit unions, specialized lenders and even credit card companies that will allow you to consolidate your credit card debts onto one card.

Ask for an outline of the loan terms in writing. Look at all the aspects of the loan, like the interest rate, repayment period, total cost for the loan and the monthly payment for the loans. Also check the fine print for any clauses that may penalize you for paying off your new loan early, maintenance fees, administrative fees or any other fees that may not be directly disclosed to you. These extras can mean big bucks for you if you’re not careful.

Paying Your New Loan

Even though your debt consolidation loan can cause some damage to your credit score in the short term, it can help your credit score in the long run, especially if you make your payments on time. Do your best to keep your new loan with the same lender. This will also help your credit score in the long run.

If you do not have any early loan payoff penalties, pay a little extra each month on your loan. This amount will help shorten the term of your loan and decrease the amount of interest you pay over the life of the loan. Even if the extra you can afford each month seems like a small amount, it can add up over time.

If you should need a debt consolidation loan, look at it as a new start. Use this time to effectively manage your credit so that you can rebuild your credit score over time. When your credit score increases and you are eligible for new lines of credit, make sure that you don’t overextend yourself. This will prevent credit problems for you in the future.