If you have a high interest rate credit card then you’ve probably looked into some debt consolidation loans to help you out of debt. These are useful in that they can lower that interest rate and help you pay down your debt quicker. There are several debt consolidation traps out there however, that make that dream even harder to achieve. They promise to make your payments lower and don’t deliver, giving you even more debt than before. This can be a problem is you’re already struggling with the debts you have. Below are four ways to recognize if you’ve fallen into debt consolidation traps, and how to avoid it if you’re considering a loan.
The main goal of taking a consolidation loan in the first place is to reduce your debt, and help you climb out of it. However, these loans don’t exactly have the best track record. 70% of those who fall for debt consolidation traps like this are more likely to end up with the same amount of debt or more just after a few years of taking on the loan. A good example would be if you used this type of loan to pay off credit card debt, but now that the card is paid off you’re most likely going to use the card to pay for something else, maxing it out again.
Why is this happening? Debt consolidation loans allow you make your debt more manageable, but that doesn’t change your spending habits. Your debts had to come from somewhere originally, and once they are paid off with a loan, if you have bad habits, you’ll just fall back into the debts you had before.
Debt consolidation loans are a bad thing when used wisely. They can be useful in making payments smaller and more manageable. However, it will only work long term if you’re willing to change your spending habits. This can save you from having to get another loan, and keep you debt free.
Expensive consolidation services
Debt consolidation traps can include the use of a consolidation service. These services can charge you interest fees, up-front fees, or monthly fees. These services don’t offer services that you can’t do yourself, and they may cost you more in the long run. These services can be a big help if you’re not sure what you’re doing or how to go about using your loan, however, if they cost you more than you’re willing to spend then it might be a good idea to explore other options.
Looking into options yourself can save you money on an expensive service. Moving your high interest credit card to a lower interest rate, or getting unsecured credit, or taking out a home equity loan are all options that you can use on your own, without the use of these services.
Paying more interest
Debt consolidation traps also include this hidden cost of a loan. You may have lowered your interest rate, which is great, but, now you have to pay the cost, which is having to pay more interest payments. The reason your payments have become lower is most likely due to the fact that the loan as stretched out the amount of time you’ll have to pay. An example of this would be if you originally had a 3 year loan on a car and after taking the debt consolidation loan it has been stretched out to 7 years. This remains true even if the interest rate has been lowered.
Taking into consideration all your debt and whether or not you can pay it off one debt at a time can save you money on interest. Use an online calculator to see how much a consolidation loan can save you, or help you to decide to consolidate at all.
Using your house as collateral
Debt consolidation traps get very serious if a home is at risk. When you put your home on an equity loan or a line of credit you put your home at risk for being lost. By using your home you are telling the lender you’re willing to put your home at risk to consolidate your debt. By choosing this option you change from an unsecured loan over a secured loan, by using your home as security. This may seem like a great idea with interest being low, but your home is your greatest, and most important asset.
If you do choose to use your home as a way to consolidate other debts be sure you are able to make that extra payment. Another important thing to remember is to leave at least 20% of your home’s equity intact for taking out a line of credit or even taking on a second mortgage. If you default on the consolidation loan you can lose your home in foreclosure, like defaulting on your mortgage.