One of the strategies that consumers employ to help them pay off debt is consolidation. Debt consolidation puts your debts together in one place, making it a little easier for you to pay them down. For some, this works remarkably well. Unfortunately, debt consolidation ends up being more problematic than helpful for most debtors.
How Debt Consolidation Works
There are two main methods of debt consolidation. One of them involves getting a third party to lump your debts together. You make one payment to the third party, and then that’s divvied up between your creditors. Often, there’s a fee charged as part of this service. You also have to be on the alert for scams.
Another method of debt consolidation is to pay off smaller loans with one larger loan. If you can qualify for a personal loan, have 0% credit card offers, or can get a home equity loan, this consolidation option would work for you.
Once your loans are consolidated into one place, you make one payment. It’s often easier to manage, and in some cases it can save you in interest, since you aren’t paying a wide variety of high rates. For the disciplined consumer, debt consolidation can work well.
Drawbacks to Debt Consolidation
While debt consolidation can be an attractive choice, it also has its pitfalls. The biggest pitfalls come with the types that involve using debt consolidation loans or balance transfers. You might transfer a balance to a 0% credit card, but what happens with the old card now that it is “freed up”?
This is an issue with home equity loans and personal loans, as well. You pay off your other debts, and all of a sudden it seems as though you have all sorts of available funds. It’s easy to rack up more debt on the free cards, even before you’ve finished paying off your other consolidated debt. Pretty soon, you’re in worse shape than you were before.
Fixing the Problem, Rather than Focusing on the Symptom
No matter your age, paying off consumer debt is a good financial move to make. However, you need to be careful about how you approach the problem. Simply consolidating your debt, without making changes to the way you manage money, won’t fix the issue. You have to look at the underlying problem, which is that you might not be living within your means.
Be honest about your finances and how you manage your money. As long as you spend more than you earn, no amount of debt consolidation is going to help. You have to first stop digging the debt hole. Then, once you have your money management under control, you can make a debt reduction plan. Debt consolidation may or may not be part of this plan, depending on your situation.
The key to staying out of debt is reforming your financial habits so that you no longer rely on debt to fund your everyday purchases. Debt consolidation can help in some cases, and it has proved effective for many consumers. But it will only work if you’re really ready to improve your finances, and disciplined enough to avoid more debt.
Have you tried debt consolidation? How has it worked for you?
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Excellent point regarding addressing the underlying issue, rather than just the symptoms. Too often people take advantage of these low or no-interest offers as a means to buy them time, but ultimately end up back at square one after the low interest period expires. Consolidating onto a home equity loan may immediately save you some interest, though potentially turns a short-term debt into a long-term one, if your extra cash flow isn’t used correctly. The traditional home loan is being used for far more than just buying a home these days. New car purchases, holidays, renovations – it’s easy to see why the average home loan balance is so high nowadays…
You’re right. Consolidation can just tack on unnecessary fees and interest if spending/saving patterns aren’t changed. We can probably see that a lot in balance transfers.
I’m glad you talked about fixing the problem. Not many people talk about that issue when they talk about consolidation.
I have had a LOT of experience with student loan consolidation. One of the things that many people don’t consider, and an issue that a lot of my friends are facing right now, is that if you elect to go back to school or get in a tough spot, you can’t pause payment. You are also often restricted from a refinancing or from pulling loans out of the larger consolidation loan. These are issues that may come up 3+ years down the line from when you originally consolidate, but it is important to read the fine print and think about possible scenarios before signing the dotted line.
Exactly right about attacking the root causes rather than just the symptoms. A fear I have with some people taking balance transfers is that it could worsen the root cause because they don’t have to worry about payments for a year or more. It’s important to have discipline.
You make an excellent point about the fact that it’s not just about consolidating debt but also about changing the spending pattern and bad habits that got you there in the first place 🙂