Will Debt Consolidation Help?
After struggling under a mountain of debt for a certain amount of time, you may seek options that can help relieve your situation. One option is debt consolidation. Debt consolidation is a process by which you get all your debts into the same account. This strategy can be beneficial for some, but it can also lead to further problems if you are not careful.
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How it Works
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The concept behind debt consolidation is that you use a loan or some other means to pay off all your debt accounts. You establish a single account that includes all your debt, which allows you to focus on one account to pay off debts over time. This method often results in getting a lower interest rate on the total amount of debt, and that enables you to make a lower monthly payment.
Tax Break
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One advantage of debt consolidation is that it may help you get a tax break. If you use a home-equity loan to pay off all your debts, you can deduct the amount of interest you pay on your debts. For example, if you have credit card debt, the amount of interest you pay on your cards is not tax-deductible. When you transition that debt to a home-equity loan, all the interest becomes a tax deduction for the year.
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Balance Transfer Issues
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If you are not eligible for a home-equity loan, you may consider using balance transfers to consolidate your debt. With this strategy, you open up a new credit card with a low introductory rate -- sometimes 0 percent -- and transfer all your balances to it. You have several months with no interest to try to pay your balances down. If you do not pay on time each month, however, you lose the introductory rate. This can result in large interest charges when the rate runs out. Also there is a fee for transferring balances, which typically is 3 or 4 percent of the balance transfer amount.
Changing the Habit
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People who have multiple debt accounts often tend to overspend. Simply consolidating your debt does not change any fundamental habits. When you consolidate debt, you make credit available on all your other accounts. If you do not change the root behavior, you probably will accumulate more debt on your old credit cards. At that point, you may not be able to consolidate your debt again, and you will be in worse shape than you were before you began the process.
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