Consumers motivation for taking out a consolidation loan

The objective of a consolidation loan is to secure one loan in an effort to repay several others. A Consumers motivation for taking out a consolidation loan is usually to acquire an overall lower interest rate and reduce their monthly payments. There are mixed opinions about whether or not a consolidation loan is the best option when trying to improve ones financial picture. However, many feel it is the only option in order to get ahead of the high interest debt that consumes them.

Although there are many different kinds of loans that people may want to consolidate...

... the most common loans subject to consolidation are credit card debts. Credit cards are often set at a significantly higher interest rate than other types of loans. Thus they are usually considered “bad” debt because of the difficulty in paying them off. If a person were to pay a minimum payment of $20 per month, on a balance of $1000 on a credit card carrying a 15% interest rate, it would take them nearly 7 years to pay it off. This is with the understanding that the card is not used at all during the repayment period. This means that more than 1/3 of the payments paid will be pure interest. Therefore the real cost of a $1000 loan in this scenario is approximately $1600, meaning the borrower will pay approximately $600 in interest to the associated credit card company. Not only are these harsh numbers they are often conservative and somewhat unusual. Most sources suggest that the average American is around $10,000 in credit card debt. Also, the standard activity of a credit card user is to make a payment and continue to use the card. With these kinds of figures it would take a lifetime to pay off most family’s credit card debt.

Another common debt is student loans. With the high cost of education it is no surprise that so many Americans are left with enormous education costs at the end of their college years. However student loans are consolidated differently since they are loans which were guaranteed by the government. Therefore the rates are based on the Treasury bill rate versus the prime rate. Due to the government handling of these programs there are restrictions on how they can be consolidated. In general, the borrower is allowed to consolidate once with a private lender and if it is necessary to reconsolidate again later it can only be done through the Department of Education.

Lastly, one more debt that many consumers prefer to consolidate is multiple auto loans.

Auto loans are similar to credit card debt in the sense that they are difficult to get ahead of; however it is a different type of loan. A credit card is calculated on a compound interest structure whereas the auto loans are calculated on a simple interest structure. In other words, with a credit card the interest is calculated monthly and then additional interest is calculated off of the original interest. With auto loans or simple interest, the interest is calculated one time and spread across the payments. However, the unique problem that occurs with vehicles is the rate of depreciation. When a new car is purchased it is capable of depreciating to ½ its value as soon as the third year of ownership. If the consumer has a six year loan on $25,000 at 9%, three years in you have paid approximately $15,780, still owe $15, 781, and the vehicle is now worth approximately $12,000. This is how people get “upside-down” on their auto loans.

After reviewing some of the types of loans that can be consolidated, it might be more clearly realized that there isn’t one answer about whether it is recommended or not to consolidate ones debt. It more so depends on the kind of debt in question and the circumstances involved. For example, it is generally not a good idea to consolidate multiple auto loans because it is really stretching out the repayment term and time is not kind to the depreciation of a vehicle (as examined previously). However, if the consumer made a large down payment and wasn’t upside-down on the loan by consolidating, and consolidation was an alternative to repossession, then it may be a viable option.

Consolidation does seem to make the most sense

... with regards to credit cards but only if the consumer stops using them and tries to double (or more) the smaller payments the consolidation affords them to make. If they do not follow these guidelines and continue to use the cards that now have a zero balance then they could very well end up in worse shape than when they began. Student loans are similar in the sense that consolidation will just spread out the debt, therefore if there is any way the consumer can maintain a higher payment and pay it off sooner that is certainly recommended over consolidation. Overall if all the aspects of the consolidation are carefully weighed it can be a valuable tool when the consumer follows a diligent plan to get back on track.