Some bank subsidiaries and consumer finance companies lend money in the form of consolidation loans. With a consolidation loan, you pay off several loans or debts by taking out one new loan. A consolidation loan can be secured (meaning you pledge some property as collateral to guarantee payment) or unsecured. In many cases, both secured and unsecured consolidation loans are a bad idea. Here's why.
(To learn about other options to avoid when you are trying to get some cash, see Options to Avoid When You Need Money.)
Finance companies make secured consolidation loans, usually requiring that you pledge your house or car as collateral. These loans are just like second mortgages or secured vehicle loans. (To learn more about secured loans, see What Is a Secured Loan?)
Here are some of the dangers of secured consolidation loans:
Finance companies and similar lenders also make unsecured consolidation loans—that is, they lend you some money without requiring that you pledge any property as a guarantee that you’ll pay. But the interest on these loans often reaches 35% or more. They also charge all kinds of fees or require you to purchase insurance, often bringing the effective interest rate closer to 50%.
If you still want to take out a consolidation loan, you are better off borrowing from a bank or credit union than a finance company. Many finance companies engage in illegal or borderline collection practices if you default and are not as willing as banks and credit unions to negotiate if you have trouble paying. Furthermore, loans from finance companies may be viewed negatively by potential creditors who see them in your credit file.
This is an excerpt from Nolo's Solve Your Money Troubles: Debt, Credit & Bankruptcy, by Margaret Reiter and Robin Leonard.