How To Determine Whether Debt Consolidation Makes Sense
July 7, 2009 by Chris Blanchet
Filed under Credit Debt
When debtors wonder whether debt consolidation makes sense, they are really faced with two possible options. Both options often distract from the true goal, which is (or should be) to improve the debtor’s personal finances. Whether debt consolidation makes sense at all really comes down to that question: “Will this improve my financial well-being?” Keeping that objective mind, facing these two options becomes less complicated.
The first option facing debtors is whether they can use the equity in their home to repay consumer debt. This was dealt with in greater in another recent article, but the bottom line is that debtors should use their home equity in order to achieve two things. The first is to obtain a better rate on their total borrowers and the second is to improve cashflow.
Whether debt consolidation makes sense in this case really depends on the debtor’s determination. If the debtor can avoid future consumer debt, then it has been; otherwise, racking up additional consumer debt only results in an erosion personal net worth and the underlying issue is not debt, but bad spending habits.
Second, if the debtor cannot secured a loan with home equity they may have to resort to an unsecured debt consolidation loan. In such cases, unsecured debt consolidation loans probably will not yield much better rates. So the question to ask will be whether or not a consolidation will improve cashflow.
For debtors who have only this option available, it is relatively easy to calculate whether debt consolidation makes sense. All the debtor needs to do is add up all existing payments and compare that figure with the payment on the new loan. If the loan payment is less, than the debtor will improve cash flow. However, will such an improvement be “enough” to carry the debtor from month to month? If not, the problem may be bigger than something a debt consolidation loan can resolve.
Obviously, using home equity to consolidate consumer debt is the ideal solution for most debtors as it will easily improve cash flow and also provide a better interest rate on all debt. If there is no home equity, or insufficient home equity, debtors need to weigh whether debt consolidation makes sense under an unsecured consolidation loan since rates will usually be much higher and loan terms much shorter. With that mind, borrowers should investigate all alternatives for unsecured loans (see below) and try to secure as low a rate as possible.
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