Debt Consolidation Dangers
Consolidation loans are a common debt relief option for those that are struggling with multiple debts and high interest rates.
By consolidating all of your debts, you can reduce the interest that you pay, but there are a lot of potential dangers involved with consolidating your debts.
It is important that you are informed about the dangers of different types of consolidation loans so you can make the right financial decisions.
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Home Owner’s Line of Credit
A home owner’s line of credit is one of the cheapest options, but that does not mean that it is the most sensible option.
The interest only payments are one of the big problems with a line of credit.
Although it means that you have a very small minimum payment, you are not actually reducing the debt unless you pay more towards the principal amount.
It requires a lot of discipline on your part and the debt will potentially be paid forever if you only pay the minimum interest payments.
It is also important to remember that, although interest rates are low right now, they are likely to rise in future and your minimum payments will increase accordingly.
Personal Lines of Credit
A personal line of credit is not secured against your home, so you will pay a higher interest rate on it.
In most cases, the interest rate is based on a Rate + system, which is tied to your credit score.
If you have an excellent credit score, you will get a low interest rate.
But people that have a low credit score due to large debts and missed payments will pay a much higher interest rate.
If you are considering using a personal line of credit, there are a few important things to keep in mind.
Firstly, is the interest rate lower than other kinds of loans?
Many people make the mistake of thinking that their debt issues are solved once they are approved for a line of credit, but then they realize that the interest rate is actually a lot higher than many of the credit cards on the market.
You also need to be honest with yourself about how disciplined you are.
If you only pay the minimum payment each month, you will never reduce the principal and you will be paying the debt indefinitely.
Although a line of credit can be a beneficial financial tool, it is not always the best option for managing debts.
Low Interest Rate Credit Cards
When considering the dangers of different types of consolidation loans, it’s important to talk about interest rate credit cards.
Low interest rate cards with a 0% introductory period are a very popular option for debt consolidation.
You can transfer the debt from all of your other cards onto the new one, and you then have a period of 0% interest (usually 6 months to a year) so you can reduce the overall amount that you pay.
However, this strategy only works if you are able to pay off the full amount before the introductory period is over.
The credit card companies are hoping that this won’t happen, and when the initial 0% interest period is over, the rate can increase by quite a lot.
In many cases, people are unable to pay off their debt during the introductory period, and they plan to find another card with a 0% interest period so they can do a second transfer.
However, this is a very risky strategy because you cannot guarantee that you will be approved for another card.
This strategy may help you to stall and defer your debt, but it won’t help you to pay it off.
Consolidation loans are the best option for many people because they charge a principal payment as well as an interest payment every month.
This means that there is a set payment period and you will clear the debt by the end of it, rather than paying interest indefinitely and never clearing the debt itself.
The interest rate will be similar to a line of credit, but you cannot borrow against it again in future so you do not risk further debt.
As long as you are able to find room in your budget for the debt repayments, a consolidation loan is a great option that allows you to pay your debts in full over a set payment period.
If you are struggling with debt and you want to know more about the dangers of different types of consolidation loans, or what your other debt relief options are, get in touch today.
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