The Three Little-Known Pitfalls of Using Debt Reduction Loans (and How to Steer Clear of Them)

By Sean Payne

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?

My dad always said that there's no such thing as a free lunch, and this definitely applies to debt consolidation loans. Getting a debt consolidation loan can be full of hidden traps that can actually get you in more trouble than you were to start with. Here's a list of the top three hidden traps of getting a debt reduction loan:

Trap #1: You're putting a band-aid on the symptom, not solving the problem.

You may think that you're curing the problem of being in debt, but debt reduction loans actually only treat the "symptom" of being in debt. These loans just put a band-aid on the problem, but don't address the behaviors that caused you to be in debt in the first place. And, once you've lumped all your debts into one huge loan, you'll eventually start to accumulate new debts when you, once again, spend more money than you make.

Any statistician can tell you that the likelihood is high that someone who gets a consolidation loan will wind up with the same amount of debt, or more, in two years or less. And remember, they're still making payments on their new debt consolidation loan.

Trap #2: Turning an unsecured debt into a secured debt.

Credit card debt is commonly known as "unsecured debt". What this means is that the loan is not "secured", or backed up by collateral (i.e. your home). Most debt reduction loans are "secured debt", meaning debt that is backed up by collateral. Most often, this means the house that you live in.

The problem with this is that if you fail to pay off your debt reduction loan, the creditor can now foreclose on your home. With the original debt, the only recourse the creditor had was to sue you in court. They couldn't come after your home.

So what you've done by getting a secured loan (AKA home equity loan) is to put your home at risk of being taken from you. Doesn't sound so smart after all, does it?

Trap #3: Now you're paying 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, how do you avoid these traps?

You can avoid each of these traps by taking the bold step of managing your own debt. Unless you're on the brink of bankruptcy, you do have the ability to get out of debt without the assistance of some lender or credit counselor. It may take some radical changes in your lifestyle, but once you make those changes you'll be curing the behaviors that got you into debt in the first place. - 23226

About the Author:

Sean Payne has been studying personal finance and how to get out of debt for over 10 years. To get more information about how to get out of debt without a consolidation loan, check out Sean's free mini-course on how to pay off your debt quickly.