What Is A Loan?

In all this talk about debt consolidation I have left out one of the most important things to talk about. That thing is: What is a loan?

Now I don't want to offend anyone with this post or assault a beginners intelligence. After all, even children know what a loan is. When a child loans another child a toy they both know that the toy is only temporarily in the possession of the other child. He doesn't own the toy. It isn't his. It is just borrowed.

We all know this definition of "loan."

Since we all have this common understanding it can be shocking to have our understanding of what a loan is, but many people do not really understand what a loan really is. You simply don't see it the way that it should be seen.

To help shake us out of the stupor of thinking we know what a loan is I want to engage in a little exercise where we look at loans from a bunch of different perspectives to get past our childhood understanding of them. We need to see them for what they really are.

A Loan From The Borrower's Perspective
The borrower probably has the worst perspective of anyone involved in the loan process. Greed and the desire for things (or education) that are well outside their means entices them to use money that is not their own.

The thinking generally goes like this:

Hi, my name is Jack and I see something that I want. I want to have 4 years of partying and drinking before I get a real job and become and adult so I am going to go to school. I haven't worked a day in my life and have no skills so I am going to ride the coattails of my dad who is loaded (at least compared to me).

Because he doesn't want me to be a free loader all my life (gosh, what a jerk!) he is making me fork out some of the dough for college too. I don't have any money so I am taking out a loan - whatever that is. I don't really care because I just know I want all the drinking and chicks that I can find at State College University.

I heard that I should read the terms of the loan and find out what the interest rate is but I don't give a rats ass. This loan is my ticket to greatness.

Sure, not everyone who takes out a loan is as oblivious as our friend Jack - but they do fall into the same traps that he does. Let's take a look at them:

• He is dead set on doing something he can't afford for all the wrong reasons. Jack wants to go to college so he can get drunk and party hard with his friends, not so that he can learn a trade or become a useful member of society. Some buy cars because they are cool or go on vacations to "relax" and take out loans to finance their unnecessary expenditure. It is all the same if you ask me.
  
• He is so dead set on it that he isn't doing his due diligence to find out what the heck he is getting himself into. He at least could have figured out what he was doing so he could pick the least deadly of all the poisons he was choosing to drink. He didn't even find out the term of his loan or its APR - both would have helped him out a lot in the long run.
  

Many people do the same exact thing with tons and tons of different circumstances. They get caught up in the moment of wanting it now so that they fail to look at it from another perspective. They should really take a second and look at it from a lender's point of view.

A Loan From The Lender's Perspective
Lender's love giving out loans. They are like little children on the night before Christmas, waiting eagerly for the bounty of presents and cinnamon sweat rolls. Think about it, who benefits from people buying things they can't afford? Who lines their pockets with interest payments? Who can make hundreds of dollars sleeping on the beach? Lenders - that's who!

Here's an example. A lender is just sitting around with $1000. He doesn't really need that $1000 because if he did he would have used it buy food, or get some clothes, or buy a house. He didn't use that money for it so it must mean that he doesn't need it. And since he doesn't need it he is going to see if he can use that money to make more money.

He lifts his head up and begins scanning the horizon for somebody who might want to use his money more than he does right now. He won't just give it to anyone - I mean they may not pay him back. He sifts through the crowd of people looking for a certain type of individual - a person with income generating potential who want something now that he can't afford.

He gravitates to this type of person like white on rice. He wants to be this persons best buddy in the universe. Do you know why? Because by lending this person money the lender can leech from them their productivity.

The lender sits down with the borrower and they work up some loan papers. They specify loan terms, the interest rate, and any penalties or fees associated with the loan. If the borrower agrees they are obligated to pay the interest on the loan. The interest on the loan is where the lender makes his money and steal the labor of the borrower.

Did the lender work of the interest? No, he simply took on the "risk" of lending the money. The interest is paid for by the labor of the borrower. What do we call a system where someone is obligated to perform work that benefits another? Slavery!

Wealth is then transferred from the borrower into the lenders hands. The decision to buy something that they could not afford has left the borrower paying twice for the same thing - once to the person they paid money to and then once again to the lender in interest.

A Loan From The Lender's Children Perspective
But here is the kicker - the lender is not the only one to benefit from his enslavement of the borrower. His children also benefit.

This works in the following way: The lender already didn't need his $1000, that is why he lent it out at interest. This $1000 is still going to presumably be around lender dies because if he didn't need it now to pay for food or shelter then there is good reason to believe that he will not need that $1000 at another time to pay for food or shelter. It can be considered as wealth.

This wealth, when the lender is good and dead, will then be distributed to his heirs - or taxed by the government - or distributed to charities friendly to the lender. Either way, these people have benefited from the borrower. They are happy because the borrow got into debt!

A Loan From The Borrow's Children Perspective
There are set of individuals who are not happy that the borrower got into debt - the borrower's children! The wealth that the lender was able to accumulate was supposed to be left to them. But their short sighted parents want to party for four years in college or drive a nicer car than they could afford. The wealth that their parents could have been building was siphoned off into the hands of already rich individuals who had the cash to bankroll a lifestyle well outside their parents means.

Kids suffer when parents go into debt. End of story.

Bringing It Back To Debt Consolidation
So what about debt consolidation loans? Where do they fall? Debt consolidation loans are still bleeding away wealth from you, your family, and your children. They can be just as bad as other types of credit in how they take away your productivity and put it in the hands of another. They are still a form of slavery. Debt consolidation loans still suck.

But the question of whether or not you should get one of these debt management tool is a calculated decision that you must make. Will it be less bad than your current situation? Will it fix your immediate cash flow problem? In a perfect world you would never have gotten into the debt in the first place, but since you have you might as well as get out of it as quickly as you possibly can while spending as little money as you can.

This is the single criteria by which to evaluate whether or not you should take out a debt consolidation loan - will it save me money?

Are Debt Consolidation Loans Good For The Long Term?

The answer to whether or not debt consolidation loans can have a long term benefit to your financial health is not as simple as it may seem. Those who dislike this financial instrument will decry debt consolidation as a band aid on a gushing wound. They suggest that this type of loan lulls those who take it into a false sense of security - the debt isn't really gone, it is still there and growing.

Then there are others who would suggest that taking out this type of loan can really help individuals (whether they be Christian or non-Christian, military or civilian, a student or a company) who are being crushed by debt to make a little breathing space so that they can focus some energy on preventing the acquisition of new debt on top of the old. How can somebody be expected to pay large sums of their salaries to their creditors and still survive? The cash flow crisis is what needs to be attended to in this circumstance.

The truth about debt consolidation loans is that both groups are 100% correct depending on your own unique set of circumstances. No two people are going to answer the question posed in the title of this post the same way because the long term benefit of debt consolidation is really not that cut and dry.

A few examples are always helpful in a situation like this. When is consolidation good in the long term and when is it bad in the long term? Let's take a look.

Bad Long Term Debt Consolidation Loans
A bad consolidation loan is going to be one where you needlessly pay out more money to your creditors than is absolutely necessary. You see, the truth about this type of instrument is that it will reduce the amount of your monthly payment by decreasing the interest rate on the loan and increasing the amount of time, or term, it takes to pay back the loan.

However, this reduction in the interest rate and increasing of the term of the loan has the unfortunate side effect of increasing the amount of money you pay to your creditors over the life of the loan. I have explained this in greater detail in another post where I talk about types of information you need when considering a debt consolidation loan.

The basic gist of it is this - the more time that interest is able to accumulate in your account the more likely you are to pay more to the bank. This is not good and is definitely the situation that you want to avoid - especially if you can currently handle your monthly payment.

Unless you are extremely pressed for cash flow, the best thing that you could do in a situation where you know your debt is an issue to cut down on expenses and simplify. Getting debt free is a lot of work and requires some serious sacrifices. Do you eat out a lot? Stop and start making your lunches and bringing them to work. The $5-10 a day that you save can help you pay off a little bit more of your credit card each month.

Are you a Starbucks addicts? Do you rent a lot of movies or see them in the theaters? Is the library a foreign word to you? Are TV shows really that much better on cable where it costs hundreds of dollars a year compared to watching them for free on Hulu or the networks website? Is soda really that important for you to drink everyday? There are literally tons of ways that many, many Americans facing crippling debt can adjust their lifestyle to better eliminate it from their lives.

You know that an extra $100-$200 a month could really help pay off your credit cards faster, right? For every extra $100 you can send to a debt with at 7% interest rate you will end up saving 58 cents a month. You might go, "That doesn't sound like very much. Why would I accelerate my debt payments?"

Here is the answer: if you can find an extra $100 a month you will pay off a $20,000 loan with a 5 year term and 7% interest rate in 47 months instead of 60 and end up saving $893. That is some pretty significant savings when you add it all up. If you can find $200 extra a month then your debt will be gone in 37 months and you will save over $1,4oo in debt payments. I am telling you, the little things add up when dealing with paying off your creditors!

So if you have sufficient cash flow to stay away from acquiring more debt, then a debt consolidation loan is probably not going to be in your best interest. You are better served with making some tough life style decisions and getting over your need to constantly be entertained. Simplify your life and reduce your expenses already! Then use that extra cash to pay down your debt more aggressively.

You can even employ one of the different versions of the debt snowball to get things rolling in your favor. Getting out of debt is sometimes more about psychology than it is about finances, so make the mental game just as important as some of the more 'practical' steps that you need to take.

Good Long Term Debt Consolidation Loans
Now that we have gotten out of the way the situation where a consolidation loan will actually be bad for you in the long term let's take a look at how these financial instruments can be useful in the long term. I have mentioned it above as well as in other posts - dedt consolidation loans are only really useful when you have a very serious cash flow crisis.

What do I mean by a "very serious cash flow crisis?" Well, whenever your expenses exceed your income I would call that a cash flow crisis. A very serious cash flow crisis is when a person's expenses exceeds both their income and their savings. This means that not only is a person not able to pay their way with their paycheck, they aren't even able to pay their way with their savings!

This type of person is a prime candidate for acquiring more and more debt. The more that they acquire, the less likely that they are able to pay off their old debts and the greater the strain becomes on their cash flow situation (since there debt payments are taking up an increasingly larger portion of their take home pay because they are forced to take on new debts every month).

At the very least, this individual is inching forward on the road to debt freedom. For every two steps they take forward on the road to repayment, they are driven one step back by having to take on new obligations.

This type of person could be a good candidate for a debt consolidation loan since it will have long term positive impact on their finances. They can escape the cycle of debt by reducing their monthly payment and freeing up some cash to begin saving for emergency expenses (like car repair, medical bills, urgent home repair, etc). Then, once they have some financial stability in their life, they can focus on ending the lifestyle that lead the the mountains of debt that led up to this situation.

They can apply all the tricks to their life to cut expenses and increase income, but they needed to establish some breathing room first so that they could stop the cycle of taking on new debt obligations. It doesn't matter if it is a secured or unsecured debt consolidation loan - heck, it might not even matter if they get the best interest rate around - what does matter is that they get a handle on their cash flow.

Conclusion
The long term impact of a debt consolidation depends largely upon the circumstance of the individual, so get informed about what will be best for you and your family.

Getting Information On Debt Consolidation Loans

The thing that people need most when considering getting a debt consolidation loan is information - lots of information. This is especially true if you don't have any experience with this type of debt management tool and you are feeling the squeeze on your finances, the stress is mounting and you need to make a decision fast.

Being new to something can be bewildering. You don't know if you are getting hoodwinked or helped by a slick sounding salesman who is offering you a solution for your life crippling debt. You simply have to get educated on the topic yourself so that you can filter out their crap and make the best possible decision for you and your family.

There several point of information that are really going to be important when evaluating a debt consolidation loan: the loan interest rate, the loan term, and the loan fees.

Understanding Loan Interest Rates
An interest rate is the essentially the amount of money that you pay your lender for the right to borrow money. So if you have an interest rate of 6% you will pay around $6 for every $100 that you borrow from someone. The reason that I say about is that there is a lot that goes into calculating how much interest you pay on your loan.

One of these things is the compounding period. A lot of loans are going to compound and accrue daily - this means that the interest that you owe on a loan gets added to the amount you owe every day. This generally means that you end up paying slightly more than 6% interest over the course of an entire year because you begin to pay interest on interest, a process called compounding in financial circles. You can avoid the compounding effect by making a payment everyday - but who it going to do that!

The key factor in determining how much interest you are going to pay is the rate of your debt consolidation loan. The higher your interest rate, the higher your monthly payment is going to be. I have explained how a debt consolidation loan is a cash flow management tool, and making sure that you get a low interest rate is going to be the deciding factor in just how low your monthly payment is. To see this, take a look at the following table I put together:

Yearly Interest Rate	Interest Per $1,000 of Loan Per Month
0.25%	$0.21
0.50%	$0.41
0.75%	$0.62
1.00%	$0.82
1.25%	$1.03
1.50%	$1.23
1.75%	$1.44
2.00%	$1.65
2.25%	$1.85
2.50%	$2.06
2.75%	$2.26
3.00%	$2.47
3.25%	$2.67
3.50%	$2.88
3.75%	$3.09
4.00%	$3.29
4.25%	$3.50
4.50%	$3.71
4.75%	$3.91
5.00%	$4.12
5.25%	$4.32
5.50%	$4.53
5.75%	$4.74
6.00%	$4.94
6.25%	$5.15
6.50%	$5.36
6.75%	$5.56
7.00%	$5.77
7.25%	$5.98
7.50%	$6.18
7.75%	$6.39
8.00%	$6.60
8.25%	$6.80
8.50%	$7.01
8.75%	$7.22
9.00%	$7.42
9.25%	$7.63
9.50%	$7.84
9.75%	$8.04
10.00%	$8.25

As you can see, the interest rate can increase the amount of your payment significantly. If you want to see how much interest you are paying to consolidate your debt simply take find your interest rate in the left column. Then find the number to the right of it (the number to the right of 10% is $8.25). Now take this number and multiply it by the amount of your loan and this will be the amount of interest that you pay in a month for that amount.

Example: a $25,000 military debt consolidation loan at a 6.25% interest rate

You would take the $5.15 (from the chart above) and multiply it by 25 ($25,000/$1,000). This equals $128.75.

To sum up, the higher the interest rate on your loan the more money you are going to have pay each month and the less likely that your attempt at consolidation will have the positive effect on your cash flow that you had hoped for. That is why getting a low interest debt consolidation loan is such an important step if you go this route.


Understanding The Term of Your Loan
The next big item on the list that debt consolidation beginners must grapple with is the term, or duration, of their loan. How long it takes to pay off your loan will directly impact the amount of money that you pay your consolidation company. A shorter term will mean a higher monthly payment but will also mean that you spend less time paying off the loan and pay less over the long term.

Here is a chart examining the effect of loan term using the military debt consolidation loan from the example above - a $25,000 loan with a 6.25% interest rate:

Term (Years)	Monthly Payment	Total Paid
1	-$2,154.53	-$25,854.41
2	-$1,110.83	-$26,660.01
3	-$763.38	-$27,481.81
4	-$590.00	-$28,319.78
5	-$486.23	-$29,173.89
6	-$417.28	-$30,044.08
7	-$368.22	-$30,930.27
8	-$331.59	-$31,832.39
9	-$303.24	-$32,750.34
10	-$280.70	-$33,684.03

As you can see, as the number of years in the loan's term increases the monthly payment decreases. You will also notice that the longer the term of the loan the more you end up paying out to your consolidation company.

The term of your debt consolidation loan is going to be very important in determining how much you pay and whether or not the loan will help or hurt you in the cash flow department. Be sure to be aware of how the term of will impact you in your given situation before you sign any agreement.

Loan Fees Matter Too
Last on the list of things that you must know and take into consideration before getting talked into a deal is the impact that loan fees are going to have on you. Here are a list of questions that are good to ask your loan officer:

• Are there any upfront fees for this loan?
• Are there any prepayment fees? A prepayment fee can be charged to borrowers who pay a loan off before the end of the loan's term. Prepayment fees can be very bad for borrowers since they usually make it so you have to pay the maximum amount of interest to your lender.
• What are the fees that I could potentially be charged and under what circumstances would I be charged them?

You are going to want to have a pen and paper available to take notes on this as you ask them. Also, be sure to ask for a list of all the fees that you could be charged so that you can feel informed about your options.

You should not feel stupid for asking so many questions! Your financial life is at stake here and you have a right as a consumer to be well informed about how debt consolidation loans will affect your finances.

A fee of $10 on a $1,000 loan with a term of 1 year is the same as adding 1% to the interest rate! Fees can add up fast so be very careful about getting a low interest rate, high fee loan - they can come back and bite you in the butt.

Information and Questions Are Key
Making sure that you ask a lot of questions is the best way to get information on debt consolidation loans. After that is some basic math knowledge (or finding tools like this site provides) so that you can analyze the information that you gathered in asking so many questions! Your debt consolidation loan should not be taken lightly and you should view it as a serious and somewhat risky step in reducing an overbearing debt load so getting all your options out on the table for you to think about is really, really important.

If you are a beginner than you simply cannot do without this debt consolidation information.

The Truth About Debt Consolidation Loans

The simple truth about debt consolidation loans is that they are not for everyone and can increase the amount of money that you pay to your creditors. With that being said, they also can be an invaluable tool in your fight to get out from under crushing levels of debt because they help you solve an immediate and very serious cash flow problem. Let's examine each of these truths in greater detail.

Debt Consolidation As A Cash Flow Solution
When debt payments make up an extraordinarily high percentage of your income a person can feel overwhelmed and out of balance. Their financial health is at serious risk because simple increases in the cost of living (such as the high gas prices that swept the US a few short months ago) can increase the pain felt by individuals and families at an alarming rate. Even worse, the could be forced to take on even more debt to survive which can have crippling effects on their financial future.

In my previous post about debt consolidation loans for beginners I introduced a fictitious character named John who found himself in $47,000 worth of consumer debt. He bought a nice car, went on nice vacations, and financed a lifestyle moderately outside his means. For the sake of this example, let's say that his $10,000 credit card debt is divided as follows:

• $6,000 on an American Express card at 9% interest
• $4,000 on a Mastercard at 11% interest

His $37,000 car loan has a 5 year term and is currently at 7%. In total, he pays about $1,000 a month to pay off his debts ($730 for the car loan, $160 for the AmEx card, $110 Mastercard).

(Note: At his current payment levels - i.e. the minimum on his credit card - it will take John 44 months to pay off his AmEx card and 29 months to pay off his Mastercard.)

To really see this example in the light of a cash flow problem we are going to need to take a look at how much John earns each month. John works at a medium sized paper company in the American north east as a salesman. His annual earnings are $40,000 a year which comes to about $2,200 a month when taxes and benefits are deducted from his paycheck.

Now let's add up all John's expenses and see where his cash flow ends up when we just take into consideration his necessities:

$ 2,200.00	Income
$ (1,000.00)	Debt
$ (650.00)	Rent
$ (150.00)	Gas
$ (250.00)	Food
$ 150.00	Total Cash Left

Once John covers all of his necessary obligation his he still has $350 left. Every last penny of this he spends entertaining his girlfriend and himself with movies, weekend trips, and various fun young people activities.

But what happens when his cost of living increases? If a roommate moves out, or gas prices double again, or food costs increase by 10%, or all of these happen at once and John is in serious debt trouble. He will be forced to take on new debt to provide for the necessities of life.

In this case, a debt consolidation loan could reduce John's payment.

Maybe he finds a good, reputable debt consolidation company that is going to offer him a reasonable interest rate of 6% for the entire balance of his outstanding consumer debt with a 10 year term. Now he makes one payment to one company instead of making 3 payments to three different companies. He also has slashed his monthly payment in half - reducing in from approximately $1,000 a month to $521.80 a month. His new cash flow looks like this:

$ 2,200.00	Income
$ (520.00)	Debt
$ (650.00)	Rent
$ (150.00)	Gas
$ (250.00)	Food
$ 630.00	Total Cash Left

Having $630 left a month is a lot more wiggle room for increased costs than $150 is. Again, the one major benefit for debt consolidation loans is that they can increase your monthly cash flow so that you can better meet your current financial obligations without taking on any more debt. However, this cash flow fix does come with a price.

Debt Consolidation Loans Increase Your Costs Long Term
The price is in increased over the long term because the term of the loan in increased while the interest rate is decreased. Before the consolidation John would have paid $54,200 to pay off his $47,000 in debt. Under the new loan that consolidates his debt he will end up paying $62,600 - a full $8,000 more than he would have been paying before the consolidation.

This is a fact that is simply undeniable and if you are interested in thinking of pursuing this reduction strategy you will definitely need to take this into consideration. Ask yourself the question: Is it better to pay less now but more over the long run, or are there some real ways that I can cut my current costs to get this debt out of the way and out of my life?

Now there is a chance that you can consolidate the debt and actually decrease the amount that you will repay over the lifetime of your loan, but these cases are extremely rare and not very likely. You are going to need a solid debt consolidation plan if you are going to be able to take advantage of these offers so make sure you know what you are getting yourself into.

Be wary of companies offer rates that look too good to be true - they may engage in tactics that end up hurting you in the long run like negotiating your debt with your creditors. This will hurt your credit score and could make it harder for you in the future when you attempt to buy a house as your interest rates could be higher as a result.

Another thing to look out for in companies that offer rates that seem too good to be true is for hidden fees that effectively increase your loans rate but get tacked on at the beginning or end of the loan. A $100 fee on the $47,000 loan represents adds .2% to the interest rate on the loan. So $1500 in fees and closing costs will effectively turn a 3% interest rate into a 6% interest rate. Be careful and read your loan documents to make sure that you only use loans that help you rather than hinder you.

When it comes down to it, make sure that you know what you are getting into before making any debt consolidation loans. Know the terms of the loan and any fees that may come. Understand how your overall costs are going to increase and how the loan will positively affect your cash flow. Be informed and debt consolidation loans because in the end you alone are responsible for you financial health.