The Downsides to Debt Consolidation
Posted by nick_niesen on October 29th, 2010
There's no doubt you'll have heard plenty about debt consolidation loans - our TV screens are full of adverts promising freedom from financial worry, and the internet is positively flooded with solicitations to lock in a low rate with a refinancing package.
If you're having difficulties keeping up with your bills and credit repayments, or even facing the prospect of recovery action on overdue installments, then the idea of debt consolidation can be very seductive. By combining all your current debts into one single loan, the theory goes, you'll be benefitting from both a reduction in your monthly repayment amount and a lifting of the stress caused by constantly having to juggle your finances.
But is debt consolidation really as simple as all that? Of course there are benefits to restructuring your financial life in this way, and the adverts aren't shy of pointing out the positive side, but before embarking on this course of action there are a few negative aspects you'd be well advised to consider. Only then can you make a fully informed decision on whether debt consolidation is right for you.
Firstly, in order to secure a lower monthly repayment you either have to get credit at a lower interest rate, or spread your payments over a longer period. Most consolidation packages rely on a combination of both, but it's almost certain that the deal will involve a lengthy loan term. This means that you'll be paying interest on your debt for longer, and the total amount of interest you'll be charged will in the long run be higher. You may feel that this is a price worth paying for reducing your monthly bills to a more manageable level, and you may indeed feel you have little other choice, but it's a point to bear in mind.
Another potential problem with consolidation is that, in a sense, you're giving yourself a fresh start financially. You're wiping out all those worrying debts and getting your finances back under control. This is of course a good thing - but you'll be left with all your old credit card accounts with a zero balance, and all the temptations to spend that that may provide. If you're not careful, you could end up in an even worse situation - having to pay back a large loan while running up new debts at the same time.
This pitfall can of course be avoided by cancelling your card accounts at the same time as you clear the balances, and it is strongly advisable that you do this.
The final problem to bear in mind is that by consolidating you will probably be shifting unsecured debt into a secured loan using your home as collateral. This means that if, in the future, you fall behind with your payments, you could risk losing your home as your creditor calls in the debt through foreclosure. This is a serious drawback, and if most of your current debt is unsecured then you might wish to explore every other possibility before tying it up to your home.
So, is debt consolidation an altogether bad option for sorting out your finances? Not at all. It can be a very effective strategy for dealing with problem debts, but it shouldn't be entered into blindly, no matter how attractive the advertisements may appear.
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