Debt consolidation consists of taking all outstanding debts, such as the credit card and car loan bills, and merging them into one monthly payment. A personal loan is obtained in order to repay the other loans, with the borrower making one monthly payment to the lender. This is advantageous for several reasons: first, the debt consolidation loan carries a lower interest rate in comparison to the interest rates of the prior loans, and second, one monthly payment is easier to budget for compared with many periodic payments.
Types of Debt Consolidation Loans
Debt consolidation loans can be either secured or unsecured. Secured loans require that the borrower provide some kind of collateral up-front, such as a car, home or boat, in order to secure the loan. Unsecured loans do not require collateral; however, they often carry a much higher interest rate.
In cases where the borrower has bad credit, a debt consolidation loan may be very difficult to obtain. An unsecured loan, if offered, may carry an interest rate that is actually higher than that of the original debt. Borrowers who have bad credit should seek out a secured debt consolidation loan if at all possible. They should also fill out multiple loan applications, since several lenders may need to be contacted before a debt consolidation loan with a reasonable interest rate is obtained.
Debt Consolidation Loan Scams
There are many debt consolidation loan scams as well. Once a potential borrower starts filling out loan applications, his or her information is shared by the credit reporting agencies with outside entities. This practice makes it easy for unsuspecting consumers to become targets of scam artists. Consumers with bad credit are especially vulnerable because they have limited choices and may be desperate to find any lender who will guarantee them a loan.
Watch out for unsolicited calls, e-mails, or letters that claim that an agency can guarantee a low-interest, unsecured loan. Likewise, if the agency asks for money in advance for “an “application fee,” or for the “first month’s payment,” this is likely a loan scam. Most reputable lending agencies work on a “contingency fee” basis and will deduct their fees from the actual loan amount that is obtained.
In some cases, the scam agency will request that a “free” loan application be filled out and the borrower’s personal information be provided. Then, the agency will request that the borrower send a security deposit because his or her credit score is lower than anticipated, or because the loan amount needs to be higher than anticipated. Once payment is sent, that agency often disappears, taking the consumer’s money with it. In addition, because the bogus agency also has the consumer’s personal information, it can commit identity theft.
Consumers who suspect that they are victims of a loan scam should contact the FTC and the police, and fraud alerts should be filed with each of the major credit bureaus (Experian, TransUnion and Equifax). Victims of loan fraud should also obtain copies of their credit reports and report any unusual activity.