Why Debt Consolidation Loans Are Often Financially Irresponsible

We are well into the New Year, and the bills may start to bite. To ease the pain, some institutions encourage borrowers to consolidate all of their loans into a “consolidation loan”, which was once described by a cynic as “consolidating all your hard-to-repay loans into one unpayable loan.”

This strategy can be justified because it allows you to take advantage of a lower overall interest rate, but remember that lenders rarely come up with a new product just because they think it will be good for YOU. Usually their thinking is dictated by how it will benefit them … in this case, by increasing their market share.

Debt consolidation loans promise a lower rate, but there are pitfalls.

Think about this scenario. The borrowers have a home loan of $ 350,000 to $ 1,987 per month, a car loan of $ 25,000 to $ 635 per month, a personal loan of $ 20,000 to $ 425 per month, and credit card debt of 5 $ 000 requiring $ 200 per month. The total debt is $ 400,000 and the overall payments are $ 3,248 per month. If they borrowed $ 400,000 to consolidate all that debt into the home loan, the repayments would drop to $ 2,270 per month, saving $ 978 per month – that’s a whopping $ 225 per week.

While consolidation can be a useful strategy in some situations, you need to understand the principles involved in any borrowing. First of all, it is the height of financial irresponsibility to take out a loan whose term exceeds the life of the property purchased with the loan. That’s why no one in their right mind takes a 30-year loan to buy a car.

If the financial problems are caused by mismanagement of money, consolidation will often draw you into more serious problems. The example assumes that our borrowers are dumb enough to bundle all of those loans into one 30-year loan at the current rate of 5.5%. Sure, that frees up $ 225 per week – but where will that money go? In almost all cases, it will be spent and credit card debt will start to climb again.

In a year or so, the couple will likely have trouble making their repayments again, but now their situation is worse as their mortgage balance has dropped from $ 350,000 to $ 400,000, making them even more vulnerable. future increases in interest rates.

Instead of consolidating, a much better solution would be to call a family reunion, explain how bad the situation is, and find ways for the family to reduce their expenses or increase their income to produce $ 100 a day. week. If that extra $ 100 were applied to speed up payments on the credit card and no other expenses were paid on the card, it would be paid off in less than a year. It’s a big if, but once you’ve learned this habit, it’s surprising how easy it becomes.

Once the credit cards are paid off, the $ 300 ($ 200 + $ 100) that is no longer used to pay the credit card could be added to the $ 425 used to repay the personal loan. At a repayment rate of $ 725 per month, it would be repaid in another 18 months.

Finally, once the personal loan is paid off, the additional $ 725 per month required for these repayments could be used to speed up car loan repayments.

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