Debt consolidation services can work for some people. When you consolidate your debt, you combine all of your debts into a single loan with a single payment. The main reason many people do this is because they hope to lower the overall interest rate that they are paying. If the new loan has a lower rate of interest than the overall rate on your current debts, you could save money. Debt consolidation services also aim to simplify the debt repayment process. When you consolidate your debt, you only have one payment to make each month, instead of several. However, there are some disadvantages to debt consolidation loans and some situations where the process won’t be beneficial.
When a Debt Consolidation Loan Won’t Work
There are several situations in which debt consolidation may be disadvantageous.
First, you may not be able to afford the payments. If you are insolvent or cannot afford to make the payments, then a consolidation loan may not help and may actually add to your stress and financial trouble. Debt consolidation does not reduce the overall amount you owe. It aims to reduce the interest rate and simplify the process of paying your debts. Note that, while the interest rate may be lower on a consolidation loan, the repayment term may be shorter, which could result in a higher monthly payment. Also, if you foresee a job loss or drop in family income, then it may be risky to take on a consolidation loan.
Even if this isn’t the case, some people may not be able to afford their debt payments, no matter how low the interest rate is. Remember, with a debt consolidation loan, you might save money on interest, but you don’t reduce the overall amount that you owe. If you can’t make your basic payments, consolidating your debt to lower your interest rate and simplify the process won’t help. This is one of the major disadvantages of debt consolidation loans. They can potentially save you on interest, but they won’t lower the amount you owe overall.
Debt Consolidation Loans Can Be Costly
Another situation when a debt consolidation loan won’t work is if the cost of borrowing is more than your current debts. If you have a lot of debt, and especially if you have missed payments on your debt, it will likely be very difficult for you to get a new loan to consolidate your debt. Debt consolidation services may not be available to you in these situations and, if they are, it can be tough to get a low enough interest rate on a new loan for it to provide significant help.
This is another of the disadvantages of debt consolidation loans. If you don’t have good credit, you won’t be able to get a favourable interest rate and the process won’t be as beneficial for you.
If the interest rate or overall cost of borrowing on the consolidation loan will be more than the costs of borrowing on the current debts, then the debt consolidation may not be the right solution, especially if the lender is going to charge exorbitant lender fees, broker fees or administrative fees. Also, if the interest rate on the consolidation loan is variable and subject to possible increase, the resulting payment and cost could be more than anticipated in the future.
Other Disadvantages of Debt Consolidation Loans
The third situation when a debt consolidation loan won’t work is because you may put your assets at risk if the consolidation loan is a secured debt. This situation is especially likely if you have poor credit. A person who has a lot of debt or who has missed payments on their debt may find that they will need to put up an asset to back their debt consolidation loan.
If you are required to use an asset as collateral, then you must be mindful that the asset then becomes exposed to seizure and sale by the creditor if you default on the loan. This is a risky situation.
If any of the above apply to you, or if you are otherwise unsure about proceeding with a consolidation loan, then you are encouraged to consult with a Licensed Insolvency Trustee prior to signing a consolidation loan. Consolidating your debts through a consumer proposal or another solution may be better options.