A perspective on debt consolidation
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.
- 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!