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Considering debt consolidation? Make sure you're aware of these two disadvantages

by , 07 April 2014
According to Nolo.com, debt consolidation is when you get a single loan to pay off all of your smaller loans, thereby leaving you with just one monthly payment rather than several. The theory is that one payment will be easier to manage and the goal is to lower the interest rate and the monthly payment while paying off your debt more quickly. While debt consolidation may seem like the perfect solution to manage your company debt, it has its drawbacks. Read on to find out what they are so you can ensure your decision doesn't backfire.

Two disadvantages of debt consolidation

Privacy Matters outlines the two disadvantages of debt consolidation:

Disadvantage #1: Debt consolidation isn't for everyone

For example, when you go with a debt consolidation plan, you're required to stop increasing your overall debt, which often includes limiting the use of your credit cards.

'If you want to consolidate, many firms will ask you to stop using your credit cards altogether,' says Privacy Matters.

Disadvantage #2: Like most loans, debt consolidators require collateral

The catch is that many debt consolidation loans are considered 'unsecured loans,' meaning that you can't negotiate a lower rate if you don't offer solid collateral in return. And even if you do have reasonable collateral to offer, it can be seized and taken from you if you can't otherwise pay back the amount you owe.


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Do these disadvantages mean you shouldn't consider debt consolidation?

Not quite.

Paul Slot, the president of the Debt Counsellors Association of South Africa, explains in an iol article that you need to first ensure that that debt consolidation:

  • Enables you to settle all your debts;
  • Reduces your overall average interest rate;
  • Reduces your monthly repayment – and that this repayment is reasonable, as a percentage of your income;
  • The credit life insurance on the loan covers you for death, disability and retrenchment;
  • The credit life insurance doesn't cost you more, and that the fees and costs of the debt consolidation loan (such as bond registration costs) don't offset any interest rate advantage; and
  • By taking out the loan you make provision for your financial needs for the next three to five years (for example, for school fees).

The bottom line: Don't just jump into debt consolidation. Make sure you consider everything – including the disadvantages . Lookout for our next article on the pros on debt consolidation.

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