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Is Debt Consolidation For You?

Updated on February 17, 2011
going crazy with bills
going crazy with bills

In this economy, many people are going through a hard time financially. There is always more month left at the end of the money. Some are struggling due to job loss, and those unemployment checks just don’t cut it. Some have a mountain of medical bills due chronic or unexpected illness. Others have put themselves in a financial bind, due to poor spending habits and bad choices. Whatever the case may be as to why you may be in debt, it is possible that you considered debt consolidation as a solution. You should dig deep to discover whether debt consolidation is a viable option in your situation.

How Does Debt Consolidation Work?

The theory behind debt consolidation is that all of your unsecured debt, such as credit cards and personal loans, are bundled up into one debt, payable to one creditor. The new consolidation loan would be used to pay off the smaller original debts at a lower interest rate. The benefits are that debt consolidation is convenient, the monthly payments are usually smaller, and you may save money in interest paid over the long haul. At least, this is what a debt consolidation company will tell you.

Debt consolidation usually comes in three forms: consolidation loans, home equity loans/home equity lines of credit, and credit card balance transfers. A consolidation loan is obtained at a bank, credit union, or consolidation loan company. A home equity loan is obtained at a bank or credit union, and your home is used as collateral to secure the loan. You can also, get a tax deduction for interest paid on a home equity loan. With a credit card balance transfer, you are essentially, moving a credit card balance from a high interest credit card to a lower interest credit card.

The Downside of Debt Consolidation

Debt consolidation is not really all that it is cracked up to be, for the following reasons. Most people who take out consolidation loans end up incurring more debt. This is because the original problem of uncontrolled spending and not saving, goes unaddressed. Furthermore, debt consolidation is nothing more than robbing Peter to pay Paul. The original debt is not eliminated, but rather it is moved from one creditor to another. If you are fairly disciplined about paying bills and monitoring your spending, then debt consolidation may work. Don’t fall into the trap of running up credit card debt again after paying credit cards down with a debt consolidation loan.

When seeking a debt consolidation loan, shop around with credit unions and banks that have good reputations. I don’t recommend obtaining a consolidation loan at a company that specializes in debt consolidation, because these companies tend to charge excessive fees. Also, if you have a very high debt to income ratio or bad credit, you might not qualify for a debt consolidation loan. In order to get a debt consolidation loan at a low interest rate, you must have a very good credit rating. Some companies offer unsecured consolidation loans, but the interest rates are higher in comparison to secured consolidation loans.

With a home equity loan, the value of your home and the equity you have built in it is used to pay down your debt. The problem with this, is that you will have turned unsecured debt, into secured debt. Your home is used as collateral in the event that you default on the loan. If some unforeseen circumstance occurs in your life and you default on the home equity loan, then the home is at risk of foreclosure. If you do choose to go this route, crunch the numbers to find out if it is really worth it. A home equity loan or line of credit that is drawn out over 15 or more years, can result in a higher overall interest payment than anticipated.

In the case of credit card balance transfers, the credit card companies will lure you in with teaser interest rates. Consumers are sometimes offered 0% interest rates on balance transfers. This interest rate is a short lived introductory rate and once it expires, the rate is hiked up to a higher interest rate. If you are good at keeping up with deadlines, you could transfer the balance to yet another credit card before the teaser rate expires. If you aren’t able to transfer the balance for some reason, you would be stuck with the higher rate of interest. You should also be aware of any fees charged in connection to the balance transfer. Also, if you miss a payment this could cause the interest to increase. Again, it is important to crunch the numbers to see if this is worth the time and effort. If your credit is already shot, then a balance transfer is probably not a viable option.

Alternatives to debt consolidation are consumer credit counseling service, debt settlement, and bankruptcy. You could also call up your creditors to see if something could be worked out to get your interest rate and monthly payments more manageable. If you pay your debt without a consolidation loan, work on paying down higher interest rate debts aggressively. Once the higher interest rate debt is paid, then you can focus aggressively on lower interest debt. The bottom line with debt consolidation is that you have to be ready to change your habits and work out all the figures to see if it is worthwhile. Cut up your credit cards and stop overspending after the debts are paid off, so that you won’t repeat the cycle of debt.

Other hubs of interest:

Is Debt Settlement For You?

How Do You Save Money in The Recession? Part 1

How Do You Save Money in The Recession? Part 2

The Basics of Coupons:  What are They and Where do You Find Them?

 

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