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Debt
Consolidation
Debt consolidation entails taking out
one loan to pay off many others. This is often done to secure a lower
interest rate, secure a fixed interest rate or for the convenience of
servicing only one loan.
Debt consolidation can simply be from a number of unsecured loans into
another unsecured loan, but more often it involves a secured loan
against an asset that serves as collateral, most commonly a house. In
this case, a mortgage is secured against the house. The
collateralization of the loan allows a lower interest rate than without
it, because by collateralizing, the asset owner agrees to allow the
forced sale (foreclosure) of the asset to pay back the loan. The risk to
the lender is reduced so the interest rate offered is lower.
Sometimes, debt consolidation companies can discount the amount of the
loan. When the debtor is in danger of bankruptcy, the debt consolidator
will buy the loan at a discount. A prudent debtor can shop around for
consolidators who will pass along some of the savings. Consolidation can
affect the ability of the debtor to discharge debts in bankruptcy, so
the decision to consolidate must be weighed carefully.
Debt consolidation is often advisable in theory when someone is paying
credit card debt. Credit cards can carry a much larger interest rate
than even an unsecured loan from a bank. Debtors with property such as a
home or car may get a lower rate through a secured loan using their
property as collateral. Then the total interest and the total cash flow
paid towards the debt is lower allowing the debt to be paid off sooner,
incurring less interest.
Because of the theoretical advantage that debt consolidation offers a
consumer that has high interest debt balances, companies can take
advantage of that benefit of refinancing to charge very high fees in the
debt consolidation loan. Sometimes these fees are near the state maximum
for mortgage fees. In addition, some unscrupulous companies will
knowingly wait until a client has backed themselves into a corner and
must refinance in order to consolidate and pay off bills that they are
behind on the payments. If the client does not refinance they may lose
their house, so they are willing to pay any allowable fee to complete
the debt consolidation. In some cases the situation is that the client
does not have enough time to shop for another lender with lower fees and
may not even be fully aware of them. This practice is known as predatory
lending. Certainly many, if not most, debt consolidation transactions do
not involve predatory lending.
Student loan consolidation
In the United States, federal student loans are consolidated somewhat
differently than in the UK, as federal student loans are guaranteed by
the U.S. government.
USA
In a federal student loan consolidation, existing loans are purchased
and closed by a loan consolidation company or by the Department of
Education (depending on what type of federal student loan the borrower
holds). Interest rates for the consolidation are based on that year's
student loan rate, which is in turn based on the 91-day Treasury bill
rate at the last auction in May of each calendar year.[citation needed]
Student loan rates can fluctuate from the current low of 4.70% to a
maximum of 8.25% for federal Stafford loans, 9% for PLUS loans.[citation
needed] The current consolidation program allows students to consolidate
once with a private lender, and reconsolidate again only with the
Department of Education.[citation needed] Upon consolidation, a fixed
interest rate is set based on the then-current interest rate.
Reconsolidating does not change that rate. If the student combines loans
of different types and rates into one new consolidation loan, a weighted
average calculation will establish the appropriate rate based on the
then-current interest rates of the different loans being consolidated
together.
Federal student loan consolidation is often referred to as refinancing,
which is incorrect because the loan rates are not changed, merely locked
in. Unlike private sector debt consolidation, student loan consolidation
does not incur any fees for the borrower; private companies make money
on student loan consolidation by reaping subsidies from the federal
government.
Student loan consolidation can be beneficial to students' credit rating,
but it's important to note that not all federal student loan
consolidation companies report their loans to all credit
bureaus.[citation needed]
UK
In the UK Student Loan entitlements are guaranteed, and are recovered
using a means-tested system from the students future income. Student
Loans in the UK can not be included in Bankruptcy, but do not affect a
persons credit rating because the repayments are recovered from the
students future salary at source by the employer before any income is
paid, similar to Income Tax and National Insurance contributions. Many
students however, are struggling with debt well after their courses have
finished
The level of personal debt in the UK has also risen astonishingly in
recent years:
"Total UK personal debt at the end of February 2008 stood at £1,421bn.
The growth rate increased to 8.9% for the previous 12 months which
equates to an increase of £111bn. |
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