At a Glance
When you’re managing multiple debts, you may be considering debt consolidation to simplify and combine debts into one easy monthly payment. But as you research, you may come across a lot of bad information about debt consolidation. That’s why today, we’re breaking down five debt consolidation myths and providing the truth behind them.
In this article, you’ll learn:
1. Debt Consolidation Changes How Much You Owe
The debt consolidation process combines multiple debts into a single debt consolidation loan or balance transfer credit card. But the mere act of combining debts doesn’t change the total amount you owe. And that’s what makes this one of the most damaging myths about debt consolidation; people think the process results in instant savings, which it won’t.
There are many pros and cons of debt consolidation, but many people choose to do it to save money over the life of the loan. And that happens by locking in a lower interest rate. That means over time, you’ll hopefully pay less than you would have without consolidating. But off the bat, you won’t see a change in your total amount of debt. So don’t fall prey to this debt consolidation myth.
2. Debt Consolidation Loans Always Save You Money
The hope of using a debt consolidation loan is that you’ll save money by locking in a lower interest rate. But if you extend the repayment term by choosing a loan with a longer payment window, you could actually end up paying more in interest.
For example, let’s say you have three credit cards you’re targeting to pay off in 3 years. Even if you lock in a lower interest rate on a credit card debt consolidation loan, if the loan term is 5 years, you could end up paying more over time. If you’re curious about debt consolidation and wondering if it can save you money, use a debt consolidation calculator to see what you may save over time.
3. Debt Consolidation Assistance is a Predatory Scam
While there are surely unsavory companies operating in the debt consolidation space, there are also plenty of reputable debt consolidation companies that can assist you with consolidating and repaying debt. If you choose to work with a debt consolidation company, make sure it’s a non-profit and appropriately registered as a 501(c)(3) organization.
You’ll also want to be on the lookout for debt settlement companies masquerading as debt consolidation companies. A major red flag is if a company asks you for a lump sum of cash with no intention of paying your creditors. It’s not a debt consolidation myth that a trustworthy debt consolidation company will guide you through the process without requesting a bunch of money upfront.
4. Debt Consolidation Creates More Debt
Some people mistakenly think that freeing up space on existing credit cards through debt consolidation will lead to more debt. But if you address the habit changes that got you in debt in the first place, falling deeper into debt doesn’t need to be the outcome.
Before you pursue debt consolidation, you can try other debt reduction techniques like the debt snowball, which focuses on paying off the lowest amount debt first, or the debt avalanche, which focuses on paying off the highest interest debt. Sometimes these options, along with setting up a well-thought-out debt management plan and a new budget, can help you stay on the right track. And using a financial professional or family member to keep you accountable means you’re more likely to continue toward debt freedom without adding to the pile.
5. Debt Consolidation Will Ruin Your Credit Score
The overarching goal of debt consolidation (in addition to saving money) is to improve your credit score. Sometimes managing multiple debts can lead to unnecessary missed or late payments. By streamlining debt into a single payment, you can improve your payment history and possibly lower your credit utilization ratio, both of which can increase your credit score.
This myth about debt consolidation likely originates because applying for a debt consolidation loan or balance transfer credit card can cause a slight dip in your credit score. But after the initial hard inquiries are made, and the loan is in place, debt consolidation doesn’t hurt your credit score; it may cause it to rise as long as the payments are managed appropriately. And if your score is already relatively low when you’re looking for a debt consolidation loan, don’t worry, as some lenders offer debt consolidation loans for low credit scores.
Why debt consolidation is a bad idea?
Debt consolidation may be a bad idea for those who are working to improve their credit score. The primary benefit of debt consolidation stems from the ability to lock in a lower interest rate. And those with higher credit scores tend to be eligible for the best offers and lower rates. Therefore, it may benefit you to wait until your credit score is in the good or excellent territory (above 650) before applying for debt consolidation.
What happens when you consolidate your debts?
Debt consolidation is the process of taking several high-interest debts and combining them into a single debt consolidation loan or balance transfer credit card. Payments become easier to manage when you do this, and you’ll hopefully save money by locking in a lower interest rate.