The Pitfalls Of A Debt Consolidation Loan
Debt Articles > Article: The Pitfalls Of A Debt Consolidation LoanIf you find yourself buried in credit card or other unsecured debt, consolidating your debts into your mortgage may be a strategy to consider. In many cases, debt consolidation is an excellent way to get your debts under control and establish a stronger financial foothold. Still, there are many disadvantages to debt consolidation loans that borrowers must consider in order to best address their unique financial situation.
The Cons of Consolidating
Many borrowers will opt to consolidate their unsecured debts into their mortgage by refinancing the loan, taking out a second mortgage, or borrowing against a line of credit home loan. While this strategy can be beneficial, there are many factors to consider, including:
- Consolidating debt into a mortgage increases the amount of debt against the property, reducing the amount of available equity. Stretching a property's equity to the max also means that the borrower has lost a potential income source in the event of a future emergency.
- You may have to pay to sell your house if you need to move in the near future. If you intend to sell the property, you must ensure that you have enough equity to pay the realtor commission and closing costs on the property, as well as the costs associated with purchasing the new home. Consolidating your debts into your mortgage may tie up too much of your equity, forcing you to remain in the property.
- There must be enough equity in the property to cover both the balance of the existing mortgage and the total cost of the other unsecured debts you wish to consolidate. If your equity is already stretched to the limit, you are unlikely to be eligible for this type of debt consolidation.
- If you default on the mortgage, your home could be foreclosed on. Therefore, borrowers must be confident that they will be able to keep up with their new monthly payments or risk losing their home.
- The total cost of the debt could increase. Although consolidating will often reduce your monthly payments and the interest rate on the loan, you can still end up paying more in interest in the long-term than you would have by paying off each loan individually.
- The consolidated debt may take longer to repay. Extending the life of the loan will likely reduce your payments; however, you will be paying on the loan for longer. Many mortgages have ten to thirty year terms, which means that you could spend the next thirty years repaying the debt.
- If you take out a variable rate mortgage (adjustable rate mortgage) rather than a fixed rate, interest rates could increase, raising your monthly payments and the total cost of the loan.
- With debt consolidation, you will only have one monthly payment. While this is often beneficial, you will not be able to pay off small loans with higher interest rates first.
- Borrowers with less than perfect credit may not be eligible for favorable interest rates. If the rate on the consolidation loan isn't lower than the rates on the individual debts, consolidating the debt would not be a wise strategy.
Other potential pitfalls from debt consolidation stem from financial management issues and future loan eligibility. For example:
- Debt consolidation makes it easier to get further into debt. With zero balances on your credit cards, you may be tempted to begin charging purchases again or continue the spending habits that led to your debt problems in the first place. If you make the mistake of taking on more debt, you could actually end up in even more serious financial trouble down the road.
- You may not qualify for new loans. Consolidating your debts may actually increase your debt to income ration, preventing you from obtaining future financing. You may also have to pay higher interest rates on future financial obligations.
Clearly, consolidating your unsecured debts into your mortgage or another loan is not a decision to be taken lightly. Debt consolidation is not always the answer; however, in many cases, debt consolidation is an excellent strategy for controlling your debt and securing your financial future. The decision to consolidate debts into your mortgage must be made only after careful consideration, calculations, and planning. Determine the costs and repayment times for each scenario prior to making a decision to ensure that you select the appropriate strategy for your financial situation. A financial professional can help you determine whether debt consolidation is appropriate for your unique financial situation.
