Christian Financial Advice and Biblical Stewardship
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Consolidate Only In Certain Circumstances

  • 2002 17 Oct
Consolidate Only In Certain Circumstances
Is it wrong for a Christian to consolidate debt by using a consolidation loan? The answer is no, not necessarily. But there are some inherent problems that must be dealt with before a consolidation loan is advisable. Larry discusses the pros and cons of consolidation loans in Chapter 18 of his book, Debt-Free Living. Basically, he says that consolidation loans can make sense, but never as a first step in resolving debt problems.

Consolidation loans are designed to help people pay off bills and pay down debt. A typical consolidation loan requires security or a co-signer. If a person is consolidating an unsecured loan, this means that he is exchanging unsecured debt for secured debt.

Although consolidation loans are usually simple interest loans (interest calculated on an annual basis) with typical interest often ranging from 22 to 24 percent or more, that is often less than the cumulated finance charges of the debts that are being consolidated, which are usually based on compounded interest (interest on the interest that accumulates daily). In addition, most consolidation loans offer lower monthly payments spread out over a longer period of time.

A consolidation loan can be a smart idea if the person consolidating does not borrow more than what is actually needed to pay the outstanding bills.

For those who already have discipline problems, borrowing more than what is needed could easily become just one more way to splurge. Therefore, if a consumer does decide to consolidate, it is imperative that he not take on any more debt.

Proceed with Caution!
What tends to happen to most that obtain consolidation loans is that by paying off their bills, they no longer receive large monthly bills from retailers and credit card companies. They then begin to feel like they do not owe as much money as they did before, and have a tendency to stop worrying once the supposed solution has been found. Therefore, they start to use one or two credit cards, and before long owe several hundred dollars in addition to their consolidation loan. However, they must resist the urge to splurge.

Unless the problems that created the need for a consolidation loan (usually overspending) are corrected, they should not consider obtaining a consolidation loan. Otherwise a year or so later all the little bills will be back again, and when they are combined with the consolidation loan, the situation will be worse than it was before the consolidation loan.

Get on a Budget
Larry believes that no one should consider a consolidation loan until they have been living for six months on a budget that controls spending. During that six months, he encourages the five following steps to eliminate as much debt as possible. If these steps are faithfully executed, a consolidation loan may not be necessary.

  1. Transfer ownership of every possession to God (Psalms 8:6, Deuteronomy 5:32-33).
  2. Give the Lord His part, the tithe, from your gross salary, first (Malachi 3:10, Proverbs 3:9-10).
  3. Allow no more debt, including bank and personal loans, and cut-up the credit cards if unable to pay them off each month (Proverbs 24:3).
  4. Develop a realistic balanced budget that will allow every creditor to receive as much as possible (Proverbs 16:9).
  5. Start retiring the debt (Psalms 37:21, Proverbs 3:27-28), beginning with the high interest debt first. If all of them are high interest, pay 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, the average family will be debt free in less than five years and the problem that caused the debt in the first place could very well have been corrected. Then once the overspending has been brought under control and if there is still unmanageable debt, it may make sense to substitute one large loan in a reduced interest rate for several smaller ones at higher rates.

Home Equity Loans?
The most common method of consolidating is through home equity loans. At first glance, it does appear to make sense to consolidate higher interest debts into one lower interest rate loan (especially if a fixed rate is offered and not a floating rate), by using home equity as collateral. However, Larry personally believes that home equity loans are one of the worst ideas ever pushed on the average family. It encourages them to put their homes in jeopardy and borrow to buy things that they can easily do without, such as cars, or to pay off things that were primarily originally purchased through overspending.

In addition, one of the primary disadvantages 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 anytime. If a borrower is not able to pay the total amount at the time of the "demand," foreclosure proceedings can be implemented without further notice.

Where to get a consolidation loan
If a person feels that he has resolved his overspending problem and still feels that he needs to consider a consolidation loan, there are several places that Larry would suggest to obtain a consolidation loan other than a home equity loan:

  • The cash value of an insurance policy.
  • Bank loans using in-bank deposits as pledged collateral.
  • Credit unions against in-bank deposit in the credit union.
  • Family loans or gifts.
  • Retirement account withdrawals or loans (borrowing from an IRA is not allowed).

Consolidation loans can at times be beneficial. However, the key to success with a consolidation loan is discipline. Once someone has consolidated his debts, he must maintain the discipline it takes to stop spending with credit. If he can not, he will often end up in deeper debt than before.