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

September 19, 2009 | Filed Under Money

If you’ve got a large amount of debt, then you’ve probably received a lot of phone calls from telemarketers offering you a debt reduction loan. At first glance, this type of loan sounds great. After all, who wouldn’t want to consolidate all of their debts into one loan with a lower interest rate?

Any wise man will tell you that you can’t get something for nothing. This is absolutely true when it comes to debt consolidation loans. Although they look good, these loans can be full of traps to snare the unsuspecting person, getting you in more trouble than you already were in. Here are the worst of the traps of getting a debt reduction loan:

Trap #1: You’re treating the symptom, not curing 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: Making your unsecured debts into secured debts.

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 big problem with secured debt is that if you fail to pay off your loan, the creditor has the right to foreclose on your home. Compare this to the original debt, where the only option the creditor had was to “see you in court”. They couldn’t foreclose on the place where you live.

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: Higher interest rates, not lower.

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.

They may change the loan in different ways, including a longer loan term, in order to offer you lower monthly payments than you’re making right now. However, this means that you will still pay more in the long run for your debts. As somebody who is already in debt, you probably can’t afford to do this.

So, what’s the number one way to avoid these insidious traps?

You can steer clear of all of these traps by deciding to manage your own debt. Unless you’re already filing bankruptcy, you still have the capability of getting out of debt without resorting to the help of some new lender or a so-called credit counselor. You’ll have to make some drastic changes to your lifestyle, but after you change your lifestyle, you’ll be well on your way to changing the behaviors that got you into debt in the first place.

Sean Payne has been learning about 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 debt consolidation loan, check out Sean’s excellent free course on how to pay off your debt quickly.

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