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Debt Consolidation - A Panacea Or a Costly Credit Card Debt Alternative?

Published on Sep 10th, 2014 - Topic: Debt Consolidation
The number of people who are unable to cope with their credit card payments is on the rise. Many people face such situation the first time in their lives and feel nothing, but panic. While inability to honor your current obligations is quite unpleasant, there are options to address it effectively.

Debt Consolidation Is Growing In Popularity

Debt consolidation is the most utilized option to manage intolerable credit card debt. As more and more people fall behind on their debt payments with recent economic downfall, it is getting more and more popular. The most common reason why people choose consolidation loans is smaller monthly payments, allowing managing debt easier. Another important reason to consolidate your credit card balances is that consolidation loans do not damage your credit, as your credit card balances drop to zero, and a new loan appears on your credit record. In fact, many consumers see a raise in their credit scores, as their decreased revolving balances affect their credit favorably in the eyes of the lenders.

The Way Debt Consolidation Loans Work

The way debt consolidation works is that a borrower takes out a loan, usually secured by home equity, that replaces the credit card debt. Such loans typically feature longer durations, sometimes up to 15 years, and have smaller interest rates. Both of these factors help the monthly payment to go down significantly, allowing for better debt management. As most consolidation loans are secured, the credit score of the borrower plays insignificant role in loan-granting decision, thus making them a great choice for borrowers with bad credit.

Debt Consolidation Loans Have Few Drawbacks To Consider

While debt consolidation loans may seem great to many consumers looking to get out of overwhelming credit card debt, they do have one significant drawback - high borrowing cost. While both, the monthly payments and the interest rates are lower, the amount of interest that lenders collect from borrowers is quite significant because they have lengthy durations. While these may be somewhat offset by tax deductions in case you take out a second or third mortgage to consolidate your debts, they are still something to consider when planning your personal finances. In addition, many debt consolidation loans feature origination fees and points, adding up to the list of your borrowing costs.

Alternative Debt Consolidation Options

There are many alternatives to debt consolidation loans, with some requiring serious financial discipline or help of a financial advisor. In case your credit card debt is not completely out of hand, you may utilize windfall method or a self-managed debt reduction plan. Windfall method is very simple: whenever you receive money that you did not expect to receive or did not count on, you should use it to pay down your debts. This money may come from employer bonus, overtime hours, tax return, inheritance, and so forth. Self-managed debt reduction plan is a more challenging endeavor. It requires a consumer to analyze the current state of finances and to budget them in such a manner that would allow for accelerated debt repayment.

It very often requires giving up costly habits, such as exchanging an everyday morning latte for an extra $100 in credit card payments per month. In addition to above, there are a number of different programs offered by nonprofit debt consolidation agencies. Such programs usually restructure your debt by renegotiating repayment terms with your lenders without the need for a debt consolidation loan.

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