Jul 03 2009
How To Determine Whether Debt Consolidation Makes Sense
When debtors wonder whether debt consolidation makes sense, they are really faced with two possible options. Both options often distract from the true goal, which is (or should be) to improve the debtor’s personal finances. Whether debt consolidation makes sense at all really comes down to that question: “Will this improve my financial well-being?” Keeping that objective mind, facing these two options becomes less complicated.
The first is whether debtors have the ability to draw on equity in their home to consolidate consumer debt. Now this was a topic of discussion for a recent a recent article but the idea behind using equity is twofold. Primarily, debtors should use home equity to reduce total average interest costs and, secondarily to increase cashflow.
What happens next becomes the debtor’s issue, but if consumer debt is not avoided on a go-forward basis, then the debtor is simply deteriorating his or her net worth. In this case, whether debt consolidation makes sense will come down to the debtor’s interest in staying out of debt and putting a real use to the improved cash flow.
Second, if the debtor cannot secured a loan with home equity they may have to resort to an unsecured debt consolidation loan. In such cases, unsecured debt consolidation loans probably will not yield much better rates. So the question to ask will be whether or not a consolidation will improve cashflow.
For debtors who have only this option available, it is relatively easy to calculate whether debt consolidation makes sense. All the debtor needs to do is add up all existing payments and compare that figure with the payment on the new loan. If the loan payment is less, than the debtor will improve cash flow. However, will such an improvement be “enough” to carry the debtor from month to month? If not, the problem may be bigger than something a debt consolidation loan can resolve.
Without question, consolidating consumer debt with home equity provides the ideal solution to debtors. In instances where there is no home equity or the equity is not enough, debtors need to work harder to determine whether debt consolidation makes sense with an unsecured loan. On such loans, rates will be higher and repayment terms shorter, meaning higher payments than, say, a refinanced or second mortgage. Since rate is the only controllable factor, debtors need to find the lowest-rate loan possible (see below) so that payments are lower.