There it is--in your mailbox, in the envelope with the exclamation points and smileys all over it. A CHECK! Made out to YOU! Sign a few documents, and you can replace all of your credit card payments with just one. What's not to like?
Maybe a lot. Remember, the big print giveth and the fine print taketh away. Unloading several monthly payments and making only one isn't a good enough reason to take on this kind of loan, especially if it's secured by a lien against your home. And that goes double if it makes your credit score worse instead of better.
1. Closing out accounts could downgrade the "utilization" portion of your credit score. For example, if you have 5 accounts with a total limit of $10,000, and you owe $6,000, you are utilizing 60% of your available credit–not the greatest ratio, but not really bad either. If you close those accounts out and replace them with a $6,000 consumer loan or home equity loan, guess what? You now have 100% credit utilization. Ouch. So instead, can you leave the old accounts open? Maybe--if your lender doesn't require that you close them, and if....big if...you have the discipline to refrain from spanking them to buy more things and blings, that's an option??just keep it reasonable--the bureaus can also clonk you for having too many open accounts.
2. Consolidation could cost more. A lower monthly payment isn't really savings--I know, that happy envelope says it is, but unless you are getting a lower interest rate too, a lower monthly payment is kind of an illusion. Your payment is only lower because your balance is being stretched out over about a million years. In fact, stretching out the debt over too much time can cost you more in the long run even if you get a lower rate. And if you don't...check out this way-too-typical scenario and hope it isn't you:
Ms. Smith has a $10,000 car loan at 7% that's three years old and she still owes $4,000. Her payment is $198.01 and she will have the loan paid off in two more years. Now, some pretty, rah-rah mailer with a check in it shows up, she bites and calls the 800 number, and the sales agent tells her (in a deep sexy voice!) that she can use that check to pay off the car loan and her payment will only be ONE THIRD as much!!!!! Well, yeah, if she uses that check her payment drops to $57 all right, but only because the $4000 has been stretched out into a ten year loan! The car will probably be on a scrap heap somewhere by the time that loan is paid off. And her interest rate actually increases to 12%! So read that nasty little fine print already.
3. The consolidation loan may have "teaser" clauses. No one likes to be teased. But just because your balance transfers start with a low fixed rate doesn't mean they will stay that way. Especially if your new consolidation loan is another credit card or unsecured account, the terms can probably change whenever the lender chooses to change them. Read the entire agreement and make sure you aren't jumping out of the frying pan and right into the fire.
Consolidation loans can be life-savers if you make smart choices. There is a reason people like them--the right one can indeed lower your interest rate, yield a manageable payment, and help you get some financial breathing room. The consolidation loans with the best rates are those secured by your home. Unlike many other products, mortgages are highly regulated. Rates can't be changed just because, and if you get a fixed rate loan your rate and payment don't ever change, which makes budgeting easier. Mortgages may also get you some some tax advantages--check with your tax pro to be sure. And because they are secured by property, debt consolidation mortgages are counted less risky by lenders and rates should be quite a bit lower than rates on the unsecured debt you'd replace.
