Understanding Debt Consolidation Loans… Here’s What You Need To Know

The literal definition of debt consolidation is replacing a number of debts with one new debt and a single payment.

Some in the Credit Counseling industry refer to the service they provide as debt consolidation because a number of payments is turned into one payment by the debtor. But in reality, with Credit Counseling, each debt and payment still exists, but is paid by the Credit Counseling firm instead. 

For the purpose of this discussion, we will consider debt consolidation the borrowing of money from a lender, usually in the form of a home equity loan, that is used to pay off a number of debts. The debtor now has one new debt and one new payment instead of a number of debts and payments.

There are a number of problems with debt consolidation, but one fundamental problem stands out above the rest. 

In today’s financial and credit climate, if you are reading this at this website, chances are, you no longer qualify for a debt consolidation loan. Things have gotten that difficult.

The home equity loan market has virtually dried up right along with home equity. 

But let’s say for a moment that you have a home with equity and you can qualify for a home equity loan, does debt consolidation make sense?

Well, maybe yes and maybe no. 

In theory, a home equity loan can reduce your debt payments as well as the effective interest rate you pay on the debt. For many people, the reduction in payment matters most. 

The down side is that your debt will now be paid in 20 years. Also, if after the home equity loan things are still tight, you have left yourself vulnerable to possible scenarios.

The  first scenario, with money tight and your credit cards now freed up, you resort to old habits and start taking on new debt. This will leave you with not only the home equity loan but credit new credit card debt as well. 

This scenario was common practice for much of the 1990’s and 2000’s. As a matter of fact, the mortgage industry depended on it. With home values rising during that time and credit standards loose, home owners were able to tap into their home equity time and again to consolidate their debt. 

But guess what? That is not the case any longer so if you fall back into the same routine after taking out a home equity loan, there is a good chance you’ll be stuck with the debt. 

The second scenario is that the home equity loan payment will become difficult to handle and you will fall into default. Now you have worsened your situation by trading unsecured debt with secured debt and in doing so, you have put your home in jeopardy. 

For most people, debt consolidation loans are not feasible. But times will change, as they always do, and these loans will become easy to get once again.

History has shown that home equity loans have proven dangerous for a lot of people. Weigh your options carefully before taking one on and consider all your other choices.