If you have a lot of debt, you’ve probably gotten several phone calls from telemarketers who offer to give you a debt reduction loan. On the surface, these loans sound great. You’d have to be crazy to not want to turn lots of small debts into one loan with a low interest rate, right?
Any wise man will tell you that you can’t get something for nothing. This is absolutely true when it comes to debt consolidation loans. Although they look good, these loans can be full of traps to snare the unsuspecting person, getting you in more trouble than you already were in. Here are the worst of the traps of getting a debt reduction loan:
Trap #1: You’re putting a band-aid on the symptom, not solving the problem.
The worst aspect of debt reduction loans is that they don’t fix the problems that caused you to be in debt. Instead, they treat the “symptom” of having debt. When you get one of these loans, you just end up with a large loan that you have to make payments on…but you will also acquire new debts when you eventually start to, once again, spend more money than you have.
Statistically speaking, people who get loans to pay off their debts end up with the same amount of debt (if not more) in as little as two years. And remember, this is in addition to the consolidation loan that they now have to pay.
Trap #2: Turning an unsecured debt into a secured debt.
Most consumer debt is what is known as “unsecured debt”. This means that the loan is not backed up by collateral. The majority of consolidation loans are “secured debt”, which is debt that is backed up by collateral. Usually, the collateral takes the form of the home that you live in.
The main problem with this is that when you can’t pay off your loan (and this is not uncommon), the creditor has the ability to foreclose on your home. On the original debt, the only thing the creditor could do was sue you in a court of law. They couldn’t take your home from you.
What you’ve done to yourself by taking out a secured loan (also known as a “home equity loan”) is to make your home vulnerable to foreclosure. Not too smart of you, was it?
Trap #3: Trading lower interest rates for higher interest rates.
Even if you opt for an unsecured loan instead of a “high risk” secured loan, you’re still going to get smacked with higher interest rates on your loan. The reason for this is that your high load of debt, along with the fact that you’re having difficulties keeping up with your debt payments, makes you a credit risk. Anyone who may be willing to grant you a loan will only do it at a higher interest rate in order to make up for their additional risk.
The use of tricky math, including a longer loan repayment term, can make these loans seem like a deal, since they may offer you a lower monthly payment than you’re currently paying. But what this really means is that you will end up paying a lot more over the long run. People who are already in debt can’t afford this.
So, what’s the best way to steer clear of these traps?
You can avoid these pitfalls by taking the daring step of managing your own debt. Unless you’ve already filed for bankruptcy, you can still get out of debt without the help of some shady loan shark or credit counseling. It may take some drastic modifications to your way of life, but once you’ve changed those behaviors that got you into debt in the first place, you’ll be well on your way out of debt.
Sean Payne has been studying personal finance and how to pay off debt for over 10 years. To get more information about how to pay off debt without a consolidation loan, check out Sean’s free mini-course on how to pay off debt fast.
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