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Debt Consolidation Loans

A debt consolidation loan is a loan designed to roll expensive, short term (credit card) debt into a longer term loan with lower interest rates. Usually this is done with a second mortgage or home equity loan, although some home buyers will roll short term debt into a new mortgage, either at the time of purchase or when refinancing the home with a new mortgage. Debt consolidation is one of those ideas that looks great on paper, but comes with several potential hidden pitfalls.

A debt consolidation loan, when viewed from a distance, seems counter-intuitive. It's going further into debt in order to retire debt. It makes sense if the debt being retired is the result of unexpected expenditures, such as medical costs or unexpected unemployment. If the debt consolidation loan is consolidating credit card debt that was accrued as the result of unrestrained spending, then a debt consolidation loan must be accompanied by a change in spending habits. Otherwise, the credit cards that are paid off with the loan are going to remain an alluring option, and soon there will be another set of big credit card charges to pay off in addition to the debt consolidation loan.

It is particularly important to decelerate on credit spending after taking out a debt consolidation loan that is secured by your home. If the household debt once again becomes unmanageable and one of the delinquent debts is the consolidation loan, it is possible to lose your house. There are a number of other reasons to look closely at using a home equity loan for debt consolidation.

A home equity loan, or second mortgage, can eliminate the option of refinancing the home when interest rates become particularly attractive. You will have to seek the permission of the lender on a second mortgage in order to refinance the primary loan. Some lenders will allow this, some will charge a fee for it, and some won't allow it at all.

Your debt consolidation loan may also render you immobile, if your home value takes a dip and becomes worth less than what you owe on it. If you wish to move, you would have to make up the difference between what you can sell the home for and what you owe on it. Many lenders will not allow second mortgages to cause your home indebtedness to exceed 80% of the home's value. Others, however, are willing to lend up to 125% of the home's value. That sort of debt consolidation loan is a good idea only if everything else remains positive - the home grows in value, you keep your job, and your short term debt does not start building again.

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