Why do you see so many advertisements for “debt consolidation” loans? They are a cash cow for the financial institutions. Their lure is almost intoxicating. They create an image of being able to reduce all your loans into one much more manageable payment that may even leave you with extra funds left over to continue living the life that got you into trouble in the first place. What a perfect solution to a nagging debt load!
What should attract your attention is that it typically finance companies and not the banks that are offering this seemingly generous solution. Its not that the banks don’t want to reap the rewards of these kinds of loans but they are likely the ones that hold your existing loans.
Typically the prime targets for “debt consolidation” loans are people carrying thousands of dollars in credit card debt, plus have substantial balances on department or big box store cards. These are the people who actually try to pay their Mastercard with their Visa.
On the surface the idea of combining all your payments into one smaller would seem like a great solution to their current debt problem, but it a recipe for disaster. Some instances will have the borrower having their monthly payments cut by as much as 50%. The finance companies count on the borrower’s short term thinking and desire to have their spending money back to blind them from the obvious drawbacks to this arrangement.
Yes, the borrower will experience the relief of seeing all his or her balances owed to the credit card companies or big box stores, wiped clean leaving only the one payment to the finance company. Unfortunately, the borrower will have likely signed a contract that could stretch for several years. You can be sure that the interest charged by the finance company will be much higher than the other lenders. Even if the rate is the same as the other financial institution, the addition of several years of payments will mean you are paying much more in the long run.
If it wasn’t bad enough that the borrower has just signed on to longer term debt, he or she now finds themselves with credit cards with no balances. Often, in record speed, they find themselves buried under a new layer of debt. One criteria for getting a “debt consolidation” loan should be that your credit cards are destroyed and any new purchases be paid for in cash!