Debt Consolidation Loan – Different Methods and Their Pros and Cons
According to figures released by the US Consumer Finance Protection Bureau at the end of 2017, there has been an increase of 9% in average credit card debt over the last couple of years. More worryingly, as per https://www.consumerfinance.gov the average balances of credit cardholders with poor credit scores increased at a faster rate (26%) in the same period. What this essentially means is that more and more people leveraging credit card debt are finding it difficult to repay their dues on time.
Consolidating Debts to Manage Outstanding Dues
Examining the possibility of getting a consolidation loan is a good idea if you have a reasonably good credit score as if it is done properly, you can not only escape the wrath of your creditors but also save substantially on the interest and other expenses. Essentially, debt consolidation is just one method of refinancing your debts. You obtain a new loan that is the sum of all the debts that you have and use it to repay them; typically, these debts can not only be credit card dues but also personal loans, payday loans or any other expense that you have incurred but not paid up.
There are multiple ways of consolidating debts; some common one examined:
Home Equity Line of Credit
If you have built up substantial equity in your home, refinancing it to access funds can make eminent sense as the rate of interest is typically very low as the property itself is available as collateral. Instead of taking out a second mortgage, you can also consider a home equity line of credit (HELOC) that can save you a fortune in interest expense as there is a massive difference between the typical home equity loan interest rate and the rate charged by the credit cards. You can also possibly get a tax deduction on the interest paid on the home loan that you would not have been able to take advantage of when paying back credit card dues. The main disadvantage is that if you default on the loan repayment due to any reason, you might end up losing your home. If you opt for a variable rate of interest, you should also keep in mind that the current low rate can change and throw all your calculations out of gear.
Credit Card Balance Transfer
If you have been paying your monthly credit card dues on time, you can always ask the card issuer to reduce their rate of interest on new purchases and waive the annual fees. You can also take advantage of balance transfer offer schemes that typically allow you an interest-free period of 18-24 months. The advantage of a balance transfer offer is that you can really save huge on the interest. The deal can be made sweeter if you can negotiate a waiver of the usual balance transfer fees. Balance transfers work out the best if you can repay all your debt in the interest-free period, else you will need to identify another card with a similar scheme before the current promotion ends.
Using Retirement Funds
Taking a loan from your IRA can be very attractive since the rate of interest is pretty low and may also be zero if you pay back the money within 60 days. It is unwise to borrow against your retirement funds in case you need the repayment period to be a long one because of multiple ramifications; not only do you not earn any interest on the borrowed funds but also can be slapped with taxes and penalties that make the cost of the funds more expensive. However, these loans are very easy to avail of by those with poor credit scores as no examination of credit history is required. It is best not to use IRA funds unless you are absolutely certain that you can pay it back within 60 days as otherwise penalties and taxes will become applicable.
Personal Loans from Family and Friends
Asking for money from family and friends can be fraught with danger even though they are easily among the cheapest sources of funds. While you can give your family an interest rate that is better than what they had been earning from their banks, things can go sour if you are not able to repay them on time or even before time if there is a sudden demand. Family and friends may find it difficult to say no to you and this can cause strains in your relationships. It is important to get professional tax advice as the interest income in the hands of your lenders may be taxable and they will have to account for it. It is a good idea to draw up a professionally drafted agreement to prevent confusion regarding rights and obligations on either side.
Loans from Institutional Lenders
Even though banks and credit unions have some of the lowest cost funds, they are typically averse to lending for private use unless you have been a model customer for years. The extent of the paperwork is large and the time taken to process loan applications can be quite long since they have very strict lending policies and requirement of good credit scores for approving loans.
Getting debt consolidation loans from private lenders can be extremely quick and painless. If you have a good credit score, the rate of interest will enable you to save a packet and you can also restructure a longer repayment period to make the monthly payment more affordable. However, it is very important to deal only with reputable lenders so that you get a fair and transparent deal and not get scammed with high rates of interest and needless charges and fees even before the loan is approved.
While it is extremely important to make the right choice for consolidating your debts, it is even more important to analyze and understand the reasons why you were driven so deep into debt. You should try and take corrective actions that will ensure that spending never exceeds your income and that you can leverage debt while keeping your exposure under control.