Planning To Consolidate Your Debt? Beware Of the Underlying Dangers

When you are burdened under heavy debt from a number of creditors, people or debt consolidation companies will persuade you to consolidate your debt. Hold on! Debt consolidation, which allows you to take out one loan to pay off all others, may not always be the most viable option for your financial needs. Though it can save you time and money by securing a lower interest rate and reducing the number of payments you make every month, there are certain potential dangers you cannot afford to ignore.

In the beginning, the idea appears to be very easy, but this quick fix may lead to more trouble in the long run. Chris Viale, general manager of Agawam, Mass.-based Cambridge Credit Corp., clears this illusion, “You’re getting symptomatic relief, not a credit cure.”

There are three main types of debt consolidation programs, let’s discuss each of them in detail, along with the dangers they can pose in future.

Paying Off Debt With Home Equity Loan

Home equity loans seem pretty lucrative. Just by leveraging the value of your house you will be able to pay off other debts. You also get tax breaks because home equity loan interests are tax deductible.

However, it doesn’t mean you must opt for home equity loan to consolidate your debt. The debt consolidation companies use your home as collateral. If, unfortunately, something unforeseen happens, you risk losing your home. With the economy in turmoil and unemployment rates at record high, you never know who will be fired next at  your workplace. And yes, the debt will still be there to haunt you!

Zero-percent Credit Card

What about those who don’t have a house? Well, in that case, many people go for zero-percent credit cards. Using this method, you switch the balance from one or more credit cards to a new one with a lower or zero interest rate for 6 to 15 months.

Again, caution and prudence is required. Companies offer low or zero interest rate in the beginning only to lure you. It won’t last forever. So, before transferring your balances to one credit card, get to know two things:

  1. When the low or zero percent interest rate will end.
  2. What the new rate will be.

Another thing, the interest rates will remain low for the given time period only if you pay on time. Just one late payment and the credit card company will push the interest rates up. Also, make sure that there are no hidden charges to surprise you in the future.

I have a tip that can save you some more money. Keep paying the debt on the new credit card without missing even a single payment, and switch to another credit card before the zero interest rate expires. However, you have to be a little cautious because getting a new credit card account so frequently may adversely affect your credit score.

Debt Consolidation Loan

Everyday, you might be getting dozens of e-mails pitching debt consolidation to be the best solution to your mounting debt problem. Convenience is the biggest benefit of debt consolidation loan. By taking one big loan to pay off all the previous loans, you get rid of paying 15 different lenders at different days of the month.

However, convenience doesn’t always mean savings. When consolidating your debt, make sure that the costs of consolidated loan are lower than the combined interest of all the previous loans. Usually, when you have nothing to get a secured loan (for example, your house or other property), lenders are highly likely to charge a higher rate.

A common problem in debt consolidation is that most of the companies are in business only for a quick buck. So, they try to capitalize on the fear of debt-ridden customers and provide them poor service at sky high fees. Worse, some of them are just out-and-out scams.

Still, paying off your debt by consolidating them into one can work for you. However, you must do two things:

  1. Analyse your current financial position to know whether or not debt consolidation makes sense for your needs (without risking your house).
  2. Verify the certifications, memberships and third-party registrations of the debt consolidation company. Check with National Foundation of Credit Counseling, Better Business Bureau or AICCCA to see if the company you are considering is a member of any of them.

Consolidating the debt without proper background research may lead you into a more complex financial mess.

Have you or any of your acquaintances experienced the dangers of debt consolidation? Feel free to share your story with us.

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