A perspective on debt consolidation

By glblguy

Wood Pile
Photo by: dbgeorge

A reader recently wrote to me saying they loved my site and tips but wondered why I didn’t talk about debt consolidation loans. This reader, like many of my readers has more than $50,000 worth of debt and I am sure the path to being debt free or even being able to make a dent in their debt seems pretty hopeless. I don’t talk about debt consolidation loans much, because I am personally not a fan of debt consolidation. The readers note however made me realize that I should probably share my perspective on debt consolidation with you.

People typically turn to debt consolidation because they want an easy fix to their debt problems. They are overwhelmed with the minimum payments on credit cards, and need some breathing room. Debt consolidation can be a good option for some, but for many it’s not.

You have to fix the real problem first

Debt consolidation doesn’t solve the real problem that got many of you where you are in the first place…you. For most people, they are debt due to overspending and not waiting until they could actually afford to purchase the items they want. I realize this isn’t true for everyone. Some people are in a large amount of debt due to personal circumstances where they had to keep food on the table and the heat on. These type of hardship situations are completely different.

If you fall into the first category (the over spender), you have to address the real problem first. You have to be willing to cut those cards up, spend less than you earn, and resist the temptation to purchase things you can’t afford. You have to change your life and your attitude about credit and debt. Until you do this, consolidating your debt won’t do anything but put you even further in debt. The quickest way to get out of debt is stop going into debt.

Debt Consolidation doesn’t reduce your debt

While the debt consolidation companies would love for you to believe otherwise, debt consolidation doesn’t reduce your debt. All it does it take all of those little piles of debt and combine them together into one big pile of debt. It also doesn’t mean you paid-off your debt, just that you moved it. If you were in $50,000 worth of debt before you consolidated, you’re still in $50,000 worth of debt after. Don’t let anyone make you think otherwise.

I enjoy listening to Dave Ramsey, and some of my favoriate calls are when people call in a say they paid off their debt. When Dave asks them how, they’ll say something like “We took out a home equity line and paid it off” or “We consolidated it and paid it off“. Quick as a whip, Dave will reply with “No you didn’t pay it off, you just moved it…Come on!“. I think he refers to them as debt CON-solidation loans.

You may end up paying more

Debt consolidation loans basically give you a longer term with a lower interest rate. Seems like a good deal. I get lower monthly payments and a reduced interest rate. What those debt consolidation companies don’t want you to know is that in most cases you will end up paying more interest. When the term gets increased, you pay less per month and thus they get to charge you interest longer.

Think about it for a minute. Do you really believe that the debt consolidation companies have a sincere need to help you get out of debt? No, they are a company that wants to make money, and they don’t do that by transferring over your debt and getting the same as the credit card companies. They do it by getting more interest.

It may take you longer to get out of debt

As a result of the longer term loan and increased interest, using debt consolidation will most likely make your journey to get out of debt take even longer. This is due to a combination of you most likely making the minimum payment on the longer term loan and them charging you more interest in the long run. I would encourage you to take a long hard look at the debt snowball and debt snowflaking techniques combined with asking your creditors to reduce their interest rates. This is the quickest way to get you out of debt, barring of course an unexpected windfall of cash.

It’s not the same as credit counseling or debt management

Don’t confuse debt consolidation with debt management and counseling companies. Debt management and counseling companies don’t move your debt. They negotiate with your creditors to work out reduced rates, new payment plans, or settlement deals. The key difference is use of debt management and counseling companies will most likely damage your credit score and you run the risk of being sued by the creditors and/or harassed by debt collection companies.

Found someone that promises to eliminate your debt? It’s a scam, run away. Nobody can make your debt go away. Be careful to of consolidation companies that want upfront fees. These are scams too. They’ll charge you a fee, than either claim they can’t do anything or just never reply.

When you should consider debt consolidation

While I would recommend avoiding debt consolidation loans all together if you can, there are a few circumstances and conditions in which I might consider it.

Conditions to met before using debt consolidation:

  • Sell everything you don’t need and use it to pay on your debt
  • You can make the payment on the consolidated loan and with some effort can pay more
  • Before you commit to the consolidation loan, get rid of your credit cards and vow to never use them again.
  • You’ve considered every other option – like getting a second job, working more hours, starting a side business, etc.

Legitimate Reasons:

  • You can’t afford to make the minimums on all of your debts
  • You are behind on your payments and can’t get caught up

If you’ve decided to go with debt consolidation, make sure their are no penalties for early payoff and make sure you can pay more than the minimum payment. This is important, because you’re going to do both right?

Have you used debt consolidation? What is your experience with it? Agree? Disagree? Want to add some thoughts? Add a comment!

24 Responses (including trackbacks) to “A perspective on debt consolidation”

  1. Mrs. Micah Says:

    Me Vs. Debt did an interesting post on using Prosper to consolidate some high-interest debts. She did it only for the ones in the 20-30% APR range. I thought that made sense…sort of moving the snowball and putting some of it together so that she won’t be accruing quite as much interest while she pays it off. But it’ll still be her highest-interest debt, I think, so she’ll be going at it.

    I think that’s why Prosper and such may be better ideas for debt consolidation than a company. If you’re looking for a way to lower the interest as you snowball your way out.

  2. In Debt Says:

    Fortunately, my situation has never been bad enough for me to consider trying debt consolidation, though I can certainly sympathize with those who feel like it is their only option.

  3. CiaranFromChance Says:

    Great post. Don’t know much about debt consolidation as I’ve been lucky and smart enough to avoid it. From this post alone I pretty much gained a good working knowledge of how it all works. Well written, worthy of a Stumble:)

  4. Mark Framness Says:

    The important thing is if you have to be resolved to stop the behaviors that got you into debt in the first place. If you do not do this you are digging in place to fill up your last hole and you end up in a hole of the same size or even bigger than the one you just filled in.

  5. glblguy Says:

    @Mrs. Micah – Thanks, I’ll have to give it a read. I’m not much on borrowing period, so to be honest I really haven’t even looked at Prosper.

    @In Debt – I tried it, not cause I needed to, but because in my financial ignorance at the time I thought it would be a good move. *sigh*

    @Ciaran – Thanks Ciaran. Wish I would have been smart enough!

  6. [email protected] Says:

    We’ve become a society of payments. People don’t ask how much the car costs, they ask what the payments are. They don’t really care about what the home costs (watch the home buying shows on HGTV), they only care if they can afford the payments.

    Some debt consolidation loans MAY offer lower rates than what you currently have, but they stretch you out from 5 years to 35 years. That isn’t progress!

    People need to multiply their payment amount by the number of payments and ask themselves if it makes sense.

  7. glblguy Says:

    Hi Mark. I completely agree. The more you dig the whole, the harder it is to get out.

  8. glblguy Says:

    @Ron – Great comment and you’re dead on. Do the math folks. That’s how many people are in foreclosure crisis now. Thanks!

  9. Cliff Says:

    Good post, but paying minimum payments on a credit card can last more than ten years at an interest rate of over 20%, a loan might be able to match that term at a rate of less than half that.

  10. glblguy Says:

    Cliff – I agree and is why I had lots of “may”s in there. It really boils down to doing the math and making sure a good deal really is a good deal. On a large credit card balance at 20% it could well take you more than 10 years.

  11. Kristen G. Says:

    Good post. Just a bit regarding debt management plans (DMPs) and debt settlement. (As an FYI, I do work for a non-profit credit counseling agency.) It’s important for people to understand that a DMP is very different from debt settlement. On a DMP the client is still making their monthly payments to their creditors. While it may affect your credit score during the duration of your plan, if it is managed correctly, you should not be sued or harassed by collection agencies.

    Often during debt settlement people are “saving up” the full payment amount agreed upon by the client and his/her creditors, and regular payments are not being made to the creditors. That is when people may find themselves in a lawsuit or bothered by collection agencies.

    Anyone in debt should carefully research all options and really understand the difference between a DMP, debt settlement, debt consolidation, etc. Also make sure the company is willing to disclose all fees and terms up front, including whether counselors receive a commission for clients they sign up to their company’s program.

  12. glblguy Says:

    Thanks Kristen, good information!

  13. sunsail Says:

    GRS reader here. Great article! You’re missing a period after your third paragraph, and “negociate” is spelled “negotiate.” I’m a proofreader/editor. These things just jump out of the page and slap me on the face. :)

  14. glblguy Says:

    Thanks sunsail I get them fixed. I wish they would do the same for me. I can stare at it for hours and not see it. Weird thing is I spellchecked it….hmmmmm.

  15. Glad Says:

    I wonder if anyone has suggestions for us. My husband lost his job last year. We lost our house, and still have a ton of debt, partly from the house. I have made a budget. My spouse won’t do a joint bank account, and gives me money irregulary that is not a set amount but seems to be whatever he wants to give up. I am going crazy with this “method”. He just put in notice to one of his two low-paying jobs and will work 4 days a week for the other one. Our lease is up in May. The budget I did was based on the advice of an attorney for Chapter 7 bankruptcy, so without “extra” spending, (or less income), we would be paycheck to paycheck. Now the funds we had for legal fees is almost gone too.

  16. glblguy Says:

    @Hi Glad – Wow, you have a lot on you. Do you go to church? Many times your church will have a financial counselor either on staff or as part of their ministry. I think that would be the first option I would look into.

    If that isn’t an option, than I would suggest you sit down with your husband and work out a plan. Seems, based on what you are saying, the plan he has just isn’t working. I don’t think the issue is joint or not (although I have a particular bias). Regardless of where your money is, it has to be properly allocated and budgeted.

    I’d suggest working up a budget together. This will allow him to understand all of the expenses and the amount of money required. Engaging him in the process will help him take some ownership of it.

    Cut back where you can, and if you can’t cut-back, find more income.

    But I would seriously reach our to your church for some help. They frequently have certified financial planners on staff or in the congregation that will help you at no charge.

    Best wishes, and don’t give up!

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