by D. Victor

Created on: February 16, 2008   Last Updated: January 01, 2010

The concept of institutionalised credit has exploded in recent time. The "buy now, pay later" syndrome resulted in individuals finding themselves owing many creditors and swimming in debt due to poor utilisation of credit. Debt consolidation loans seek to reduce the worries of the indebted by transferring their accumulated debt into one loan. Like anything else, debt consolidation loans have merits and demerits.

Pros of debt consolidation loans:

1) Easier management of finances

With a single loan payment, people can track their obligations without missing a payment due to information overload. For those who have more than ten loans, this is a significant advantage. The fact that there is one payment to one creditor makes it easier to communicate with your creditor and resolve any problems or issues.

2) Reduced interest rates

The most familiar debt consolidation loan is the home equity loan or second-mortgage. The rates offered on this loan are lower since a mortgage is a secured loan. Unsecured loans carry a higher repayment rate because they are based on your credit history or salary in some instances. The reduced interest rates would lead to a lower monthly payment than the aggregate of all previous loans.

3) Tax breaks

Depending on current tax incentives, the interest paid to a mortgage can be written off as tax incentive.

Cons of debt consolidation loans:

1) Higher loan repayment period

The debt consolidation loan usually operates for a longer period since it is typically a mortgage. This means that you would be in debt for longer even though the monthly burden is reduced. This lengthier loan repayment period implies that you would pay more nominal interest towards debt repayment than you would have had to if you dealt with eliminating loans individually.

2) Lapse into bad spending habits

The easier payment method of the debt consolidation loan may encourage the indebted to start using credit cards and other credit facilities, which would further increase the debt burden.

3) Greater risk of loss

Due to the fact that the debt consolidation loan would be secured, defaulting on this would lead to loss of collateral. This is unlike a credit card payment, where defaulting would result in a bad credit rating only.

Debt consolidation is neither absolutely good or absolutely terrible. It is just a tool. Whether it is good or bad depends on how you use it, considering your circumstances and the terms and conditions offered by the debt consolidation loan.

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