A Consolidation Loan: When Does It Make Sense to Refinance Your Debt
I’m going to let you in a little secret. Not everyone who is trying to tame their debt needs bankruptcy. In some instances, taking out a debt consolidation loan to refinance your debt is the best option.
There, I said it. Now every other bankruptcy attorney in town wants to throw a rock at me!
In all seriousness, debt problem-solving is largely about proportionality. What I mean by that is if someone has $50k in debt, but they make $200k per year, their debt is probably manageable. Whereas if someone has $50k in debt, but they make $30k per year, they are in trouble. So for someone who’s debt is pretty proportional, using a debt problem-solving tool like bankruptcy isn’t necessary. It probably makes more sense to use a less invasive option to resolve your balances. This is where someone might consider a loan to re-finance the debt.
Quick aside – these loans are often called a debt consolidation loan. A debt consolidation loan is a little different than a debt consolidation plan. A debt consolidation plan is not really a loan at all; its a means of settling your debts by putting the money into a settlement pool.
Second quick aside – we do not offer loans of any sort, so you’ll want to explore these options with a third party lender or broker. We do settle debts, but we don’t lend (in fact, we aren’t allowed to under our professional rules).
How Does a Consolidation Loan Work?
OK, I’m going to start with a fictitious character Bernard. Bernard has $50k in debt. He is making minimum payments to 10 different creditors totaling $1,500 per month. Bernard makes okay money and he has an okay credit score, but the debt is still a lot to keep up with.
Generally, if Bernard wanted a Debt Consolidation loan, he would contact one or more lenders, and ideally he would get approved for a loan that was large enough to pay off the whole $50k balance. This way, instead of having to make 10 payments, he’s making one. Even more ideally, the interest rate is lower on the new loan than the 10 accounts he had before (if the interest rate isn’t lower, you might want to consider not including that debt in the refinance.
Secured v Unsecured Debt Consolidation Loan
Often, it can be hard to get larger loans unless it is secured. A secured loan is “attached” so-to-speak to a home or other real estate. Generally a secured loan is known as a “home equity loan” or “home equity line of credit.” Secured loans usually offer an opportunity for a larger loan amount and a more aggressive interest rate, but if you don’t make the payments, you could lose your home. Also, there can be fees in secured loans to cover the cost to record the paperwork with the county to show the loan is secured.
Here is where as a bankruptcy lawyer, I would tell you to proceed with caution. A home equity loan doesn’t go away in bankruptcy (there are exceptions, but that’s another story). So if this is a larger debt that could be wiped out in bankruptcy, you don’t want to be a position where you put it into a home equity loan, and then you can’t afford it and lose your home!
Some other thoughts:
- Make sure you work with a refinance lender that is credible. Don’t trade a couple of interest points for a lender that will give you a terrible and frustrating experience. It isn’t worth it.
- Use a loan calculator to make sure the numbers make sense.
- Consider using a website that will shop you against several lenders.
- Set your payment on auto-debit.
- Make sure to look for any fees for the loan.
OK, so that’s a nut-shell. If you aren’t sure where on the scale you are in terms of proportionality of your debts, give us a call. We offer a complimentary half hour discussion with an experience attorney to review your situation and see what options make sense.