Dangerous Debt Consolidation Loans
by Kevin Adelsberg
Now that the frenzy of refinancing has tapered off, many mortgage lenders
have turned to alternate methods of marketing their services. Many banks have
started pushing harder to sign up customers for home equity based debt
On the surface, debt consolidation loans offer cash-strapped consumers some
relief from high interest rates. Looking deeper, consumers should be wary of
both the pros and cons of this fast growing practice.
In their simplest forms, debt consolidation loans are refinance agreements,
second mortgages, or home equity loans. All three loan options allow homeowners
to cash out part of the equity in their homes in order to pay off other debts.
For borrowers who have watched their homes appreciate in value, a debt
consolidation loan can eliminate the burden of multiple monthly payments without
significantly affecting the amount of their monthly mortgage payment.
On a mathematical level, debt consolidation loans can make much sense. A home
owner who struggles to make the monthly minimum payments on her 21% interest
rate credit cards can roll those balances into her 7% mortgage. The debt doesn't
go away, but the rate goes down by two thirds. In many cases, she would only
continue to pay about the same amount per month for her mortgage, freeing up her
cash flow for other uses.
As a side benefit, borrowers can deduct a portion of their mortgage interest
payments from their income taxes each year. Though not a huge savings, many
taxpayers love the opportunity to look forward to a larger tax return.
The danger lies in the borrower's loss of security on two levels. First, if a
home should suddenly depreciate, a debt consolidation loan customer could
quickly find himself or herself "upside down" on the loan, owing more than what
the house is worth. As long as that borrower continues to make payments, they'll
survive. But, they will be unable to sell their home without absorbing a loss.
For families who need to move in order to accept job transfers or pursue
educational opportunities, this can be a devastating blow.
Second, although the lending bank handles paying off the customer's outstanding
debt, the customer must personally close their old credit accounts. For many
customers, the temptation to keep those accounts open is far too great, and they
find themselves deeper and deeper in debt. In effect, the debt consolidation
improved their cash flow, but reversed their financial course. Without immediate
intervention, these customers often find themselves on the road to bankruptcy.
When investigating debt consolidation loans, consider your long-range plans. If
you intend to stay in your current home for a long time and can handle the
potential risk of depreciation, and if you can exert the willpower to close out
your paid off charge accounts, then a debt consolidation loan may be a
reasonable option for you.
Kevin Adelsberg is a writer for FDLoans.com. For additional articles and an
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