Debt Consolidation: Is a Debt Consolidation Loan Right for you?
By MortgageCreditProblems.com ColumnistMortgage Credit Problems Columnist
Walking, Bankruptcy or a Loan?
Before deciding to walk away from your mortgage or file for bankruptcy protection, you might consider a debt consolidation loan. The single reason that a loan is preferable to either of the other options is that you have a better chance of saving your credit, which you will need to secure housing and employment.
Borrowing from Your 401(k)
The first place people usually think of borrowing is from themselves. You have probably depleted your saving account and are looking at your 401(k). If you are like most people, your 401(k) has almost certainly already taken a big hit. Borrowing against is if your employer allows is a better option than withdrawing the money--when you add on taxes and withdrawal penalties, using your 401(k) money is a losing proposition. Besides the taxes and penalties, you will never be able to recover employer contributed dollars, and what's left might not be enough to cover your needs.
Borrowing from Your Home
Many people have used their homes as de facto banks for everything from home improvement to vacations, to education to pocket money. This was especially true before 2007. However, if you have equity in your home and you are in serious debt, consider a home equity loan.
Borrowing from Family or Friends
The next place most people think of borrowing from is family or friends. Borrowing from relatives or friends can work, as long as there is a repayment plan in writing, the details are clear to all parties, and you are able to adhere to the terms until the loan is repaid. There many upsides of this arrangement. Money, including interest, stays in the family. There is no loan application process. The interest rate is usually the same or better than you can get anywhere else. The downside is that loans from family and friends can irreparably ruin relationships. Depending on your situation, this type of loan can be the riskiest of any you might consider.
Debt Consolidation Through Personal Loans
Another source of cash is a personal loan through a bank or other lender. Interest rates on personal loans are still in the double digits, but the rates may be much better than what you are currently paying on your credit cards. Your rate will be determined by a number of factors including your FICO score, your history, if any, with the lender, the amount to be financed and the length of the loan. Depending on your creditworthiness, you may or may not be able to secure a personal large enough to pay off all your higher interest obligations.
Traditional Debt Consolidation Loans
If you do not own a home or are upside down on your mortgage, you may still be able to get a debt consolidation loan. In this case, your interest rate will usually be considerably less than your credit card rate, but you will be paying interest over a much longer time.
The Pros
There are many solid reasons for consolidating debt: lower interest rates, lower monthly payments, the convenience of just one payment versus several, relief from collection calls, and peace of mind.
The Cons
With so many positives, what could go wrong? There are two things to look out for when consolidating your debt. First, beware of ripoffs. If you are solicited, you might be the target of a scam. You should not pay upfront fees or sign away the title to your property. Thoroughly research any unfamiliar company you are thinking of doing business with including checking with the Better Business Bureau. Second, remember that credit card debt is unsecured. By rolling it into a a loan that is secured by your home, it is much harder to discharge if you must later declare bankruptcy.
How to Decide
The best way to decide if a debt consolidation loan is right for you is by finding out what is available to you. Use an online debt consolidation calculator to help you understand your potential savings. And tap into websites where you input your basic information and then receive quotes from multiple lenders for consolidation loans. If you are still unclear or undecided, work with a unbiased third party such a your tax adviser or a HUD counselor.
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