Re-structuring a loan is not always that simple

If you have a lot of debt - credit cards, car loans, finance companies, the local furniture store - and are considering paying it off with a "home equity" loan, take caution before taking advantage of this "opportunity."

As any financial planner, loan officer, or lender understands, whether you should "consolidate," "restructure," or "refinance" a loan or mortgage is not always as simple as whether the interest rate is lower than the present interest rate you are paying. Here are a couple of things to keep in mind.

  1. If you cannot afford to make your loan payments now, repaying a consolidated loan - even though it's in one lump sum - probably will not be easier.

  2. Most people have a lot of "unsecured" debt. Unsecured debt means that if you miss a payment, you can be sued, but you won't immediately lose any of your personal property because you did not pledge it as "security" to get the loan. The most common example of unsecured debt is a credit card. If you miss a payment on your Discover card, you can be sued for the balance; however, you are not faced with immediate repossession of the items purchased.

    Secured debt, however, is debt that is secured by something you own, like your home or your car. If you miss a payment on a secured debt, you could lose the item that you pledged as security, or collateral. Consequently, if you restructure all of your unsecured debt into a home equity loan (which uses your home as security) and you miss one or more payments, you run the risk of losing your home.

  3. The interest rate may be lower, but the monthly payment or the total amount paid may not be lower. Getting lulled into refinancing because of a lower interest rate or a lower monthly payment is a common mistake people make. While a lower interest rate may seem to save you money, the period of repayment may be longer than your current loan, and you actually are paying more in the end. Similarly, if you are making a lower monthly payment, but the interest rate or the period of repayment is longer, you could be paying more than if you stayed at the higher monthly payment. If you are having trouble making your present monthly payment, however, this may be a viable option.

Refinancing, consolidating, or restructuring your existing debt may be a good idea but the options can be confusing as well as misleading. If you aren't careful, you could actually end up in an even worse financial situation.

 

Note: This information was prepared as a public service by the Illinois State Bar Association and is a joint project with the Illinois Press Association. Its purpose is to inform citizens of their legal rights and obligations.

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