by Christy Bieber | Sept. 7, 2019
Consolidating your debt could be a good or bad thing for your finances -- but it depends on your situation. Find out here if debt consolidation would be a financial life jacket or a financial disaster.
Debt consolidation is a simple process in which you qualify for a new loan and use the funds provided by your new lender to repay one or more other debts. You can consolidate all different kinds of debt. That’s because your new loan could be used to pay off credit cards, medical debt, payday loans, or other personal loans.
In some cases, debt consolidation can be a great way to pay down debt faster and give you more wiggle room in your budget. But in other cases, it can leave you much more deeply in debt and can make debt payoff cost more. Whether debt consolidation will help or hurt you depends on your specific financial situation and your intentions.
To figure out how consolidation is likely to affect you, ask yourself these questions before you get a consolidation loan.
Consolidation makes sense under one circumstance only: when it makes paying existing debt more affordable. If you can qualify for a consolidation loan at a lower rate than the one you’re paying now, then consolidation might work. After all, if you can reduce your rate from 15% or higher on a credit card to 6% or 7% on a personal loan, your interest costs will be much lower.
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Typically, you’ll need pretty good credit to qualify for a consolidation loan at a good rate. If your credit is poor because you have tons of existing debt or have been late on payments, then you may be unable to get a consolidation loan at a better rate. There are some scammers out there that advertise debt consolidation loans even to people with bad credit -- but these loans often charge high interest or high fees. Getting one of these will probably be worse than the debt you currently have.
Always know the details -- including rates and fees -- of any consolidation loan you’re considering. If it’s not a good deal, don’t do it.
Consolidation can make you feel like you’re doing something to pay off your debt. After all, it can make interest costs lower and sometimes even reduce monthly payments -- and it can free up credit lines on cards you owed a lot on.
In reality, though, consolidation is just moving debt around. Yes, it can help you to pay it off faster by reducing the cost -- but only if you are committed to actually paying off your consolidation loan ASAP and not continuing to borrow.
Unless you have budgeted to pay off your consolidation loan and to live within your means, you can’t afford to mistake consolidating debt for taking responsibility for what you owe. If consolidation delays you facing up to your debt problem and creating a real solution, then you’re not doing yourself any favors.
It’s not just the monthly payment that affects the cost of your consolidation loan -- it’s your repayment timeline, too.
If your consolidation loan has a longer repayment period than your current debt does, you could end up raising the total cost of debt repayment. This happens because you pay interest for a longer time. Stretching out repayment can make interest costs go up, even if your new loan has a lower interest rate. So, while it may be tempting to take a consolidation loan with a very low monthly payment and a long repayment timeline, this will usually hurt your finances.
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Some people also use balance transfer credit cards to consolidate debt. Balance transfer cards allow you to transfer the balance from one or more existing cards onto a new card offering a 0% promotional rate. But, that 0% rate lasts only for a limited time. If you can’t pay off the full transferred balance before the 0% rate ends, you’ll be charged interest at the card’s standard rate on the remaining debt balance. If that standard rate is higher than the rate on the cards you transferred the debt from, you could end up paying more interest in total.
One of the biggest dangers of debt consolidation is that you free up credit on existing credit cards. If you aren’t living on a budget and 100% committed to not using your cards for purchases you can’t afford, you could quickly get into really serious financial trouble.
Once you start reaching for your credit cards again, you could find all that credit you freed up with your consolidation loan is used up very quickly. That will leave you with your consolidation loan and your credit cards to pay off -- which is clearly a financial disaster.
You not only need to avoid overspending and ending up back in debt, but you also need to make sure you can keep your spending low enough that you’ll have the cash to make payments on your consolidation loan. Otherwise, if you’re late on a payment or default on your consolidation loan, you’re going to ruin your credit.
Lowering your interest rate and simplifying the debt payoff process can be huge benefits of debt consolidation. You can pay much less interest and become debt free faster if you do it the right way. But make sure you don’t put yourself at risk of financial disaster by consolidating to the wrong loan or consolidating when you’re not committed to handling your new loan -- and freed up credit cards -- responsibly.
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