Should You Use Debt Consolidation For Debt Elimination?
Saturday, February 7th, 2009 Subscribe To Our Feed
Debt consolidation loans are usually in the form of a second mortgage. The equity that has been accumulated in a home is used as collateral to get a second mortgage, and the proceeds from that second mortgage is used to pay off debts, many of which are unsecured debts.
I am neither advocating nor panning debt consolidation loans here. But before you get a debt consolidation loan in order to alleviate your financial woes, you do need to fully understand what you are doing, why you are doing it, what the cost could be, and if it will, in fact, solve your debt elimination problems.
The equity in a home is usually the largest single asset that a family has. Equity is made up of the down payment that was made when the home was purchased, the amount of the principle of the loan that has been paid off, and any increase in the value of the home over the years.
Home loans, including second mortgages, are secured debt. The home is the collateral for the loan. If you default on your mortgage payments, you can lose your home. That’s the way it works. And instead of having debt elimination, you have no home!
When you take out a consolidation loan in the form of a second mortgage, you are very literally betting the farm (the house) that you can make the payments each and every month in full and on time. There is more. Unsecured debt is debt for which you have not pledged any collateral — think credit card debt. When you charge a purchase to a credit card, you have not used any of your assets as collateral for that loan. And credit card purchases ARE loans. If you use the proceeds from a second mortgage to pay off unsecured debt, it becomes secured debt.
