Common Debt Consolidation and Restructuring Pitfalls
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A debt consolidation loan, or debt restructuring, can be a very important tool to use as part of an overall debt management strategy, especially for those that have multiple consumer debts. The idea behind a debt consolidation loan is to use it to pay off two or more debts. The new loan will ideally have better overall terms than the other loans individually.
Debt consolidation loans can come in a number of different forms. You need to be aware of the differences to make the best decision.
- Fixed rate – provides rate and payment stability at the cost of a higher initial interest rate.
- Variable rate - offers a lower short-term rate but carries the risk of a payment that could increase.
- Secured loan – typically has a better interest rate than an unsecured loan because the borrower has pledged a valuable asset that can be taken by the lender in the event of default.
- Unsecured loan – the loan is guaranteed only by the borrower. Usually carries a higher interest rate than a secured loan.
Debt consolidation loans seem simple enough, but there are common pitfalls that consumers should avoid.
Common Debt Consolidation Loan Pitfalls
- Paying too much attention to payment – Many consumers consider payment to be the cost of a loan. The actual cost of a loan is the interest that you pay on the loan each month. Disreputable consumer finance companies know this, and they try to focus your attention on how much you are saving in payment each month. They often achieve this by extending the term of the loan rather than providing a lower rate. The best debt consolidation loans will have a lower payment, lower interest cost and may be even scheduled to pay off sooner.
- Paying too little attention to terms – Consumers are often so desperate for a way to fix their finances that they overlook onerous terms hidden in loan agreements. Review your loan docs carefully. Be on the lookout for prepayment penalties, balloon payments, and rate or payment adjustments. Ask for sample versions of documents to review at home before signing loan documents. Never sign loan papers if you do not fully understand all of the loan terms.
- Failure to “shop around” – Consumers are busy, especially if they are carrying excess consumer debt. The first company that you price a loan with is not likely to offer the best rate and terms. Never sign loan papers the same day you apply for a loan. There are many online resources that can help your check and track rates on debt consolidation loans.
- Lack of a debt management strategy – Consolidation loans are often used by consumers to improve a temporary situation, such as a need for cash flow. The problem is that the short-term fix can lead to long-term financial problems down the road. Make sure that you consider not only how you will get the debt consolidation loan but also how you will pay it off.
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