At a Glance
Debt consolidation can be a positive step if it’s done correctly, but there are several things that can go wrong if you don’t do your homework. One of these is mistaking debt settlement for debt consolidation. They are not the same, even if the offers you receive in the mail look similar. We’ll cover that and other potential pitfalls of debt consolidation.
In this article you’ll find:
What is Debt Consolidation
Think of debt consolidation as a strategy to lower interest rates and make debt payoff simpler by breaking it down into fixed monthly payments. The only requirement for debt consolidation is the ability to get approved for a debt consolidation loan. Once that loan is secured, you can use it to pay off all your other debt, leaving you with just the monthly loan payment to make.
This is a good strategy for consumers with high-interest credit card debt. For it to be effective, the interest rate on the loan needs to be lower than the average interest rate on the credit cards. One of the more common debt consolidation mistakes is neglecting to check that. If the loan rate is higher, you don’t really gain anything by consolidating debt.
Disadvantages of Debt Consolidation
Consolidating debt into a single monthly payment seems appealing until you start to fall behind financially again. That’s the point when most consumers start to use their credit cards. Before they know it, the card balances are high again and they still have the loan payments to make every month. In that scenario, debt consolidation can hurt your credit, not help it.
Borrowing money, AKA taking on more debt, to pay off credit cards and existing loans only works if the borrower changes their spending behaviors. Far too many consumers get caught in this trap. Ideally, strict budgeting and spending discipline would come before the debt consolidation loan. If those are implemented, the loan may not be necessary in the first place.
Other Ways Debt Consolidation Can Go Wrong
For those who don’t read the fine print, a debt settlement arrangement can look very similar to a debt consolidation plan. We’ve heard many stories about consumers engaging in a debt settlement deal, thinking it’s debt consolidation, only to be notified by credit card companies that their payments are late, which impacts their credit score.
Another common mistake is rushing into a debt consolidation plan because the offer looks attractive. Taking out a loan is a big deal. It puts you on the hook for another monthly bill and it doesn’t solve the underlying problem that got you into debt in the first place. Seek out other options like changing your spending habits before venturing down this path.
The Bottom Line: Debt Consolidation May Not Be Right for You
Debt consolidation is not a bad idea, but it might not be the right choice for you. It’s not a magic pill to solve all your problems. Create a budget, evaluate your spending, and make extra payments on your credit cards before you apply for a debt consolidation loan. If you do this, you may not need debt consolidation, so don’t assume it’s the only way out of debt. There are other options.
Frequently Asked Questions
What is the downfall of debt consolidation?
The downfall of debt consolidation is the false sense of security it creates for the compulsive spender. Paying off credit card debt, only to start running it up again right away, is a surefire way to damage your credit score and keep you drowning in debt.
Why you should never consolidate debt?
Never say never, but if your credit score is bad and you can’t control your spending, debt consolidation won’t help you. The interest rate on the loan will be high and you’ll be back in the same boat within a few months; these are the debt consolidation negative effects. Correct the spending problem first.