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Should you use a consolidation loan?

By Lucy Lazarony · Bankrate.com
Tuesday, January 11, 2011
Posted: 11 am ET

A consolidation loan offer, such as one sent to you from your credit card company, can look mighty enticing. Especially if you're feeling bogged down by credit card debt and are tired of sending payments to several different cards each month.

But before you sign up for a consolidation loan, you'll want to weigh the pros and cons carefully.

Here are some important questions to ask before applying for a consolidation loan offered by a credit card company or any other lender.

What's the interest rate on the loan? Does the loan charge a variable or fixed interest rate? How does the rate compare to interest rates currently being charged on your credit card debt? Will it save you money? If so, how much? Bankrate's debt consolidation calculator will help you crunch the numbers.

Consolidation loans only make sense if a consumer is going to save money and get out of debt faster, says John Ulzheimer, president of consumer education at SmartCredit.com.

How much credit card debt are you looking to consolidate? Take a close look at the amount of credit card debt you're thinking about consolidating. Is it $5,000? Is it $10,000 or even higher? Unless you have good credit, you may have difficulty qualifying for a larger consolidation loan.

"There is no guarantee that the consumer will even qualify for a loan large enough to pay off all their higher-interest credit card debt," says Ulzheimer.

How good is your credit? To qualify and get a good rate on a consolidation loan, you'll need good credit. Folks with banged up credit may have difficulty qualifying for a loan or get stuck paying a much higher interest rate.

"As with any other loan the standards are based largely on credit quality," Ulzheimer says. "You won't be able to qualify for the loan if your credit is poor. And even if you do, it might not be financially in your best interest to do so."

It's a good idea to ask about the credit qualifications for a loan, before you apply.

"Ask them their credit qualification guidelines so you don't waste time applying for a loan you have no chance being approved for," Ulzheimer says.

Don't overlook loans available from local lenders, such local banks and credit unions. Once again, you'll need good credit to qualify.

"You might even have better luck with them because they are going to understand the local economy much better than a lender who is a more national player," Ulzheimer says.

Choose your lender carefully. Before applying for a consolidation loan, take a close look at the lender offering the loan. Is the loan being offered from a reputable bank or credit union, a credit card company you've been using for years or from a debt management firm that you've never heard of?

"I'd stick with reputable lenders for these and all types of loans," Ulzheimer advises. "If your credit card issuer happens to also be a big bank, which most are, then using the same company is fine.  But I would not use whoever you have your savings, checking or investment accounts with."

Before choosing a consolidation loan, you'll want to weigh the pros and cons of other debt management options, including signing up for a debt management plan with a credit counseling agency, working out a debt settlement or simply transferring high-interest credit card debt to a new card with a lower interest rate.

Choose the option that makes the most sense for your wallet and your credit.

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