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Debt consolidation usually entails rolling many loan amounts into one at a lower interest rate in order to reduce monthly repayments. Sometimes an asset may be used as security for the new consolidated loan, so if you default on the loan, the security can be sold to collect the remainder of the proceeds.
Debt consolidation loans often extend the original terms of a loan. If the balance would have been due in 12 months, the deadline can be extended to 18 months without penalty.
Pauline Heng, Operations Manager at Collection House Limited, states debt consolidation does not work effectively to change people?s bad spending habits. The method does not treat the problem of why someone has gone into debt in the first place. It simply enables them to take longer to repay the debt and it encourages them to continue with their bad spending habits.
Consolidating debts may give you the impression that the monthly repayments and interest rate have been reduced, however the amount of debt that is still outstanding has not reduced in any way. This means that the loan has been extended to a longer term, which may possibly take years to repay.
Studies have shown that about 70 per cent of the time after someone has consolidated their credit card debts, the debt grows back because they haven?t learnt to use cash or haven?t stopped making purchases on credit. It may also indicate that they haven?t saved for an emergency fund either.
Let?s assume you have $30,000 in unsecured debt, including a two-year loan for $10,000 at 12 per cent, and a four-year loan for $20,000 at 10 per cent. Your monthly payment on the $10,000 loan is $517 and $583 on the $20,000 loan, for a total payment of $1,100 per month. The debt consolidation company offers you a lower repayment of $640 per month and an interest rate of 9 per cent with all your loans rolled into one. That means you would pay $460 less per month in repayments.
The debt consolidation company has extended the term of your loan for six years. But did you know that by deferring the term of the loan, you are actually paying more in interest?
You will now pay $46,080 to pay off the new loan instead of $40,392 for the original loans, even with the lower interest rate of 9 per cent. This means you paid $5,688 extra for what seems to be a lower repayment.
This example shows that debt consolidation is just a manner of shifting the debt from immediate to longer term. Pauline Heng advised the only way to get out of debt is by changing your spending habits. You need to commit to a saving goal and pay down the debt.
Are you thinking about consolidating your debts?
Source: http://womenintheblack.com.au/does-debt-consolidation-work/
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