Debt Consolidation - Essay Example

Debt Consolidation Debt consolidation is a process that involves taking of a loan to settle many other loans. The primary reason for doing this is to acquire a single loan with a lower interest rate which is normally at a fixed rate, instead of paying higher interest payments to a number of lenders. This is also done sometimes simply for the convenience of having just a single lender to deal with. This technique could involve the transferring of liability of a number of different unsecured loans into one unsecured loan, or it could involve the transferring of the liability of the unsecured loan into a secured loan by pledging an asset as collateral ('Debt Consolidation,' par.2). An agreement on collateral against the loan gives a lower interest rate for the loan, as the risk factor decreases. Naturally, if there's no collateral against the loan, lenders don't have any form of security for their money and they resort to charging a higher interest rate. So if the true purpose of debt consolidation must be achieved, it is advisable to keep an asset as collateral so the lenders can make a forced sale on non-payment of the loan and so that the borrower can receive the low interest rate he's looking for. This method has been proven successful when dealing with credit card debt, as credit cards often carry a much larger interest rate than even unsecured loans. In an interview, Kerri Cole talked about her practical experience in dealing with her debt problem. She went to Credit Consolidation Services and got her interest payments reduced on all 9 credit cards she owned; one of the card's interest rate fell from 27% to 9%. For a small monthly fee, she is saving over $600 a month since she started debt consolidation which makes a rough figure of $7200 saved each year. Though some companies tend to take advantage of these situations and indulge in predatory lending, the particular company Kerri talks about has been refreshingly fair and accommodating to her problem. Predatory lending is a term used for lenders who use deceptive methods to convince borrowers to agree to harsh and unfair loan terms, or the systematic violation of the terms by the lenders in such a way that it is very hard for the borrower to defend against it ('Predatory lending,' par.2). In recent reports, media has raised concerns over debt consolidation. They have pointed out that a large majority looks to reduce their interest rate by converting their unsecured loans into a secured loan. The problem arises at their choice of asset to secure the loan against. Most people tend to secure their loans against their home ('Debt consolidation,' par.13) which is a dangerous practice; putting at risk such a valuable asset would certainly not be the most advisable thing to do. The monthly payment does get lower, but the actual amount repaid over the years is often significantly greater in proportion due to the long period of loan. What people argue is that debt consolidation mostly cures the symptoms of the problem and doesn't hit at the root cause of the disease. To owe someone money is always very stressful. The stress is compounded when you owe money to not one, but quite a few lenders. Debt consolidation can provide means to develop a workable budget, and it would greatly reduce the stress level by bringing the number of lenders down to one. This would also be beneficial in the sense that one is less likely to forget a due payment of a single lender than attending to a large number of lenders, each with their own separate terms. Often it happens that because of a non-payment, you get further fines and charges on late payment; a debt of $500 could rise to $700 just because of an imposed fine. Debt consolidation will lessen that amount back to the principle amount (Selman, par.3). So, through debt consolidation we are looking at numerous advantages like no fines or monetary charges, reduced number of lenders, a lower interest rate and no warning calls. Also with your credit rating improving because of debt consolidation, if you are looking for a new loan, you wouldn't generally be required to make interest payments at the premium rate. Where it is seen as an effective method of bailout, it also has its share of drawbacks. If someone gets involved with a small lender for debt consolidation and the lender goes out of business, it may pass the borrower's loan agreement to a third party who might not be as sympathizing as you want ( 'advantages and disadvantages of debt consolidation,' par.6). This could put the borrower in serious legal and financial problems. At times, even debt consolidation wouldn't give you the best interest rate. For example, it is more practical for a person having few credit cards to transfer all his debt to the lowest interest rate credit card instead of going through all the hassle of settling on a debt consolidation agreement. Dave Ramsey, the American financial writer is especially critical about debt consolidation. He calls saving of interest and a smaller payment both myths and re-iterates the belief of a lot of other writers that believe debt consolidation only treats the symptoms. In his view, this technique is nothing more than a 'con' as it leads you to a false sense of security that your debt problem has been solved (Ramsey, par.1). In reality, the debt is still there and so are the habits that caused such a problem in the first place. True debt help is neither quick nor easy. He quotes some statistics of a company where it was calculated that 78% of the people who consolidate their debt see a rise in their overall debt after the consolidation. This is primarily because the person hasn't found a workable solution to pay off the debt or at least reduce his spending. The other thing Ramsey is critical about is that what's not often realized is that the reason interest rates get lower is because of the longer time duration of the debt. The reason debt consolidation business exists is because in a longer term loan, the borrower eventually ends up paying more over the years than it normally would without applying debt consolidation. Most debt consolidation companies do often declare themselves to be non-profit but make a lot of revenue at their customer's expense. He offers a very simple solution to the debt problem: to change one's spending habits. One should commit to a set plan and stick to it for the debt problem to finish. The solution could be emotional, but it is far from rocket science. Bibliography "Predatory Lending." Wikipedia. 6 Apr. 2009. 9 Apr. 2009 . Selman, Gibran. "The Unique advantages of Debt Consolidation." Ezine Articles. 3 Oct. 2006. 10 Apr. 2009 . "Advantages and Disadvantages of Debt Consolidation." Super Pages. 11 Apr. 2009 . Ramsey, Dave. "The Truth about Debt Consolidation." Daveramsey.com. 11 Apr. 2009 . Read More