The Pitfalls of Debt Consolidation Loans

By Jeanine Skowronski,

New research from the National Endowment for Financial Education finds that these loans, which allow a cash-strapped consumer to restructure multiple debts for a low monthly payment, leave borrowers with a greater overall debt burden by stretching the payments out over longer periods.

For example, NEFE says, a five-year loan for $20,000 at a 10% interest rate would cost about $425 a month and total interest payments of $5,496 for the life of the loan. Extending the debt to 15 years in a consolidation loan would knock down the monthly payment to $215, but it would increase the total interest payments to $18,685 – a fact that is conveniently left out of most debt consolidation advertisements.

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"Typical ads tell consumers that the monthly payments will be low and that their debt will be reduced," researcher Paul Bloom said in an official statement. "And although the ads sometimes tout lower interest rates, most people who need such loans don't qualify for the lower interest rate loans."

NEFE says the loans also sometimes carry hidden fees (for items like credit checks or attorney services) and penalties (for late payments), which many ads do not disclose either. Some companies even charge a fee just for applying for such a loan.

The discrepancies, often masked by advertising and labels such as "credit counselor," highlight the need for debt-ridden Americans to shop around before accepting a debt consolidation loan offer.

For additional steps you can take to ease your money woes, check out MainStreet's roundup on eight steps to real debt consolidation.

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