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The Pros and Cons of Debt Consolidation

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How Does Debt Consolidation Work?

Debt consolidation usually involves taking out a low interest loan at a fixed rate to reduce monthly payments. This often entails rolling many loan amounts into one. An asset is used as collateral for the new consolidated loan. The most commonly used asset is a home. This means that if the consumer defaults on the loan, they agree to allow the house to be sold to collect the remainder of the funds. This method of debt management is usually secured to pay off student loans or credit card debt that carries large interest rates that may increase frequently. There are pros and cons to debt consolidation.

The Positive Side of Debt Consolidation

On the positive side, it allows consumers to pay down the principle amount faster. As a result, credit scores may increase. This is especially useful when the consumer is trying to secure a mortgage to buy a home. The consolidation takes many small payments, with variable high interest rates and rolls them into one monthly payment with a lower interest rate. This takes away the stress caused by trying to manage many payment due dates to avoid late fees. The smaller payment makes it easier for most people to create a budget they can stick to.

Debt consolidation loans often extend the original terms of a loan. If the balance would have been due in six months, the deadline can be moved back to 12 or 18 months without penalty. If a home equity loan is involved, the interest may be tax deductible.

The Negative Side of Debt Consolidation

One of the disadvantages to this type of program is that it does not teach the consumer new habits, it just enables them to continue the bad spending habits that have already been established. If they don’t stop using their existing cards, debt will continue to build and their credit may be negatively affected.

Debt consolidation does not work for everyone. Many people believe that a consolidated loan is easy to get. While that may have been true at one time, it is not today. If your credit is still in good standing, it may be the most appropriate option. Though the monthly payments and interest rate has been reduced, the amount due has not. This means that the loan has been stretched out which will possibly take years to repay. It is only shifting the debt from immediate to long-term. Many people find debt settlement more appropriate for their situation.

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Written by dailyspends

January 26, 2012 at 10:19 am

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