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Debt Consolidation
Debt consolidation entails taking out one loan to pay off many others. This is
often done to secure a lower interest rate, secure a fixed interest rate or for
the convenience of servicing only one loan.
Debt consolidation can simply be from a number of unsecured loans into another
unsecured loan, but more often it involves a secured loan against an asset that
serves as collateral, most commonly a house. In this case, a mortgage is secured
against the house. The collateralization of the loan allows a lower interest
rate than without it, because by collateralizing, the asset owner agrees to
allow the forced sale (foreclosure) of the asset to pay back the loan. The risk
to the lender is reduced so the interest rate offered is lower.
Debt consolidation is often advisable in theory when someone is paying credit
card debt.
Credit cards can carry a much larger interest rate than even an
unsecured loan from a bank. Debtors with property such as a home or car may get
a lower rate through a secured loan using their property as collateral. Then the
total interest and the total cash flow paid towards the debt is lower allowing
the debt to be paid off sooner, incurring less interest.
Because of the theoretical advantage that debt consolidation offers a consumer
that has high interest debt balances, companies can take advantage of that
benefit of refinancing to charge very high fees in the debt consolidation loan.
Sometimes these fees are near the state maximum for mortgage fees.
In addition,
some unscrupulous companies will knowingly wait until a client has backed
themselves into a corner and must refinance in order to consolidate and pay off
bills that they are behind on the payments. If the client does not refinance
they may lose their house, so they are willing to pay any allowable fee to
complete the debt consolidation. In some cases the situation is that the client
does not have enough time to shop for another lender with lower fees and may not
even be fully aware of them. This practice is known as predatory lending.
Certainly many, if not most, debt consolidation transactions do not involve
predatory lending. |
