Debt consolidation is a form of debt refinancing that entails taking out one loan to pay off many others. This commonly refers to a personal finance process of individuals addressing high consumer debt. It is a useful tool for many borrowers, to simplify their finances and often save money in the process. However, it is not the right path for everyone. Moolr has taken a look at common debt consolidation errors.
If you borrow for a longer term the loan may feel “cheaper” because the monthly repayments will be lower. But overall a lot more interest will be charged. Paying a lower monthly amount is not necessarily better for your finances if you end up paying more in the long-term. Not only will you be paying more interest, but you will be stuck with the loan for longer. The date when are free of the debt will be further away.
This could restrict you in other ways. If you want to save up for a house deposit or increase your pension contributions or start a family, you are postponing the opportunity, perhaps, to do such things. Many mortgage-lending rules make it much harder for you to get a mortgage if you have debts.
Not all debt is a burden that hangs over you, nor something that must be gotten rid of as soon as possible. The main benefit of consolidating debt is to reduce payments by reducing your interest rate. To make your debts cheaper. But if you already have a competitive rate on your debts, even if they are on multiple accounts, there is little to gain by consolidating.
Also if you currently own a large loan that is costing you a lot each month but only has a few months to go, don’t re-finance this as you will then be paying interest on it for a lot longer. See it through, as soon as you will be free of the debt.
Now this is a grey area, as elsewhere on Moolr we have discussed the advantages of leaving credit cards open to help improve your credit rating. However, if that is not an urgent factor for you, it it better to close cards you have a zero balance on.
If you leave cards open, then at some point it is likely you will use the cards again. Many of us know this all too well. Perhaps you mean to pay it all off quickly, but other urgent problems may arise and soon your credit card debt is rising again and you also have the large loan to pay off. As a trade off, perhaps keep one card for emergencies. Reduce its credit limit so that you are restricted to how much you can use it.
Secured loans may seem like a good idea at the point you take them out. However, should your circumstances change, they can quickly turn into a nightmare. With an unsecured loan, you do not put your assets at risk, but instead your ability to borrow in the future. Should you struggle to make payments on a secured loan in the future, you could lose things important to you – even your house! Think carefully before going down this path.
Here at Moolr, we always look to source credit for those that may have struggled in the past. However, the result of such loans is that interest rates may be higher. Thus, it is not really a good idea to use such a loan to consolidate loans, as you will end up paying more in the long term.