News Articles

FIRST-PERSON: Calculating the wisdom of consolidation loans

GAINESVILLE, Ga. (BP)–Appropriately handling personal finances should be a priority issue in a person’s life. In an attempt to get debt under control, many people choose debt consolidation. Combining debt by using a consolidation loan isn’t wrong for a Christian, but there are some inherent issues that must be dealt with before a consolidation loan is advisable. It may make sense to consolidate your debts but never as a first step — not until some basic problems are first resolved.

Potential benefits of consolidation

Interest on consolidation loans is usually simple interest, calculated on an annual basis, and the interest can be rather high, but generally less than the accumulated finance charges of the debts being consolidated, because they’re usually based on compounded daily interest. Most consolidation loans offer lower monthly payments spread out over a longer period of time.

A consolidation loan might be a good idea if no more is borrowed than is needed to pay outstanding bills. However, when a person with discipline problems borrows more than is needed, additional debt quickly accumulates. If you consolidate, you must not take on more debt.

Proceed with caution

When most people obtain consolidation loans to pay off existing bills, they no longer receive large monthly bills from retailers and credit card companies. That can give the appearance of not owing as much money as before, and the tendency might be to suppose a solution has been found. It then becomes easy to start using credit cards and, before long, hundreds of dollars of debt repayment mounts up — in addition to the consolidation loan.

If the problems that created the need for a consolidation loan (usually overspending) aren’t corrected, a consolidation loan should not be considered. Otherwise, in a very short time all the little bills will be back again, and when they’re combined with the consolidation loan the situation will be worse than it was before.

Plan a budget

Never consider a consolidation loan until you have first lived on a budget that controls your spending for at least six months. During that time, use the following steps to eliminate as much debt as possible. The good news is that if these steps are faithfully carried out a consolidation loan may not be necessary.

1. Transfer ownership of all your possessions to God (see Psalms 8:6 and Deuteronomy 5:32-33).

2. Give the Lord his part, the tithe, from your gross salary (see Malachi 3:10 and Proverbs 3:9-10).

3. Allow no more debt (including bank and personal loans) and cut up your credit cards if you’re unable to pay them off each month (see Proverbs 24:3).

4. Develop a realistic balanced budget that will allow all your creditors to receive as much as possible (see Proverbs 16:9).

5. Start retiring your debt (see Psalms 37:21 and Proverbs 3:27-28). Begin with the high-interest debt first. If all of them are high-interest, pay off the one with the smallest balance first. Once the smallest is paid off, put all the money on the next, and so on.

Generally speaking, if these steps are followed, most families can be debt-free in less than five years and the problem that caused the debt in the first place could very well be corrected. Once the overspending is under control and you still have unmanageable debt, it might make sense to substitute a consolidation loan at a reduced interest rate for several smaller ones at higher rates.

Prudently consider home equity loans

One common method of consolidating is through a home equity loan. It certainly appears to make sense to consolidate higher interest debts into one lower interest rate loan by using a home’s equity as collateral (especially if a fixed rate is offered and not a floating rate).

However, home equity loans can place a family’s home in jeopardy, because the money is often borrowed to buy things they can easily do without, such as new cars or paying off things originally purchased through overspending.

In addition, one primary disadvantage of using a home as collateral for an equity or consolidation loan is that most home equity consolidation loans are demand loans. This means that the bank or lending institution has the right to “call” the loan due at any time. If a borrower isn’t able to pay the total amount at the time of the “demand,” foreclosure proceedings can be implemented without further notice. This isn’t the sort of debt relief most people had in mind.

Consider some optional sources

If you have resolved your overspending problem and still feel that a consolidation loan is required, there are several places to obtain money other than a home equity loan:

— The cash value of an insurance policy

— Bank loans using in-bank deposits as pledged collateral

— Family loans or gifts

— Retirement account withdrawals or loans (you cannot borrow from an IRA)

A consolidation loan might be beneficial for you. But remember that the key to freedom from debt is discipline. Once you have consolidated debts, discipline must be maintained in order to stop spending with credit. If you can’t do this, you might end up deeper in debt than before.
Burkett is chairman of the board of Crown Financial Ministries, which merged last year with the ministry he founded in 1976, Christian Financial Concepts. A Southern Baptist layman based in Gainesville, Ga., Burkett is the host of the national “Money Matters” radio program and author of two resources published by LifeWay Christian Resources of the Southern Baptist Convention: “How Much Is Enough? 30 Days to Personal Revival” and “Jesus on Money.”

    About the Author

  • Larry Burkett