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Debt Consolidation

Debt consolidation loans are sometimes used to manage debt problems. Rather than paying off several separate bills each month, you can consolidate debts with a financial institution that will arrange for one lower monthly payment extending over a period of time.

Like everything else, what really matters is the price you are paying. For loans, what you’re looking at is the interest rate (often called the annual percentage rate or APR) and the fees. If you understand this you should be in good shape. The bottom line is you want low fees and a low interest rate for the life of the loan. This means you should watch out for: introductory interest rates that automatically increase to a high rate after the initial period, hidden fees, prepayment penalties and interest rates that may change over time.

Debt consolidation loans should not be confused with offers to repair credit or debt management plans (DMPs). “Credit repair” offers may seem like a reasonable solution when your bills become unmanageable. But before you do business with any company, check it out first. Some businesses that offer to help you with your debt problems may charge high fees and fail to follow through on the services they sell. In addition, some companies guarantee you a loan if you pay a fee in advance. The fee may range from $100 to several hundred dollars. Resist the temptation to follow up on these advance-fee loan guarantees. They may be illegal in some states. Debt management plans are used by credit counseling agencies. See the Credit Counseling section for more information.

What to watch out for when considering a debt consolidation loan:
  • Be sure to reduce your interest rates — not just your monthly out-of-pocket costs.
  • Some debt consolidation loans allow you to take extra cash to use for any reason. Resist this temptation or you may end up even further in debt.
  • You might be able to consolidate your debts through a second mortgage or a home equity line of credit. A secured loan may carry a lower interest rate. As long as you make your payments on time, these loans can cost less than unsecured loans. On the other hand, these loans require you to put up your home as collateral. If you can’t make the payments — or if your payments are late — you could lose your home.
  • The costs of consolidation loans can add up. In addition to interest on secured loans, you may have to pay “points,” with one point equal to one percent of the amount you borrow.
To understand credit card fees, visit Costs of credit cards.