Consolidation Loans: Should you get one?

Many Muslims have debt. A car loan, a credit card, a line of credit, etc. The sad reality is that all of this debt comes is interest-based. Usually, this is coupled with high payments and high levels of interest, and feelings of crushing debt. Naturally, many people seek out solutions to this problem, and often times this comes in the form of a consolidation loan.

What’s a Consolidation Loan?

A consolidation loan is a loan that combines all the loans that you currently have and rolls them into one. It usually involves a lower interest and lowers payment than the combination of all your other debts. For example, if you have credit card debt of $2000 with 19% Interest, a car loan of $8000 with 9% interest, and a line of credit of $15,000 with 5%. interest. Combine these debts could be costing you $600-$800 per month in cash flow. By consolidating you would have a single debt of $25,000 interest of 6% payment of maybe $400 per month. Basically, this method frees up $200-$400 of monthly cash flow.

Here are a few things to keep in mind

1) Consolidation loans only work if you use that “extra cash flow” to pay down the principal.

Often time I see people go for consolidation loans in order to pay to free up cash-flow and get out of debt more quickly. This is not a bad idea by itself, however, oftentimes I see clients who take a consolidation loan, have an extra $200 per month, and proceed to spend that on things that are unnecessary. If you take a consolidation loan. Make sure the extra cash flow goes to attacking the principal!

2) Cancel the stuff that got you in trouble.

A major failure that I have seen is people will go to the effort of getting a consolidation loan but not close their credit cards and lines of credit. Now they have to contend with their consolidation loan as well as the temptation of their line of credit and freed-up credit cards. Some go on a spending spree and end up in an even worse financial position than they were before.

3) All of these contain interest

Currently, most of these loans and consolidation options are interest-based. I will never say any of them are halal. I am saying that a consolidation loan can be used to get you out of interest-based debt more quickly. If you get one, work your butt off to pay it down and get out of interest. No more stress.

All in all a consolidation loan to pay down debts is not a bad idea. However, it can be a disaster if it is not handled properly. If a consolidation loan will cause you to go even deeper in debt or have you putting less money towards your debt it should be avoided.