Should I Use Debt Consolidation?
Debt consolidation is a method of managing debt. In some cases, it makes the difference between financial stability and teetering into monetary disaster. Debt consolidation isn't for everyone, however, and at times it doesn't save you money. You must know the advantages and disadvantages of consolidating, as well as when consolidation is appropriate, before applying for a consolidation loan.
Other People Are Reading
-
What Happens in Consolidation
-
When you consolidate debt, you take out a new loan. You use the money from that loan to pay off some or all of your old creditors. This means you have to pay just one lender instead of several.
Advantages
-
Consolidation means you are paying fewer creditors per month. For some people, this makes tracking debt easier. Consolidating sometimes reduces the overall amount of interest you pay on the debt. It also has the potential to reduce the amount you pay on your debt each month, as you can arrange with your lender to extend the amount of time over which you'd pay the balance. Your credit score may go up, because you use the loan money to pay off old creditors in full.
-
Disadvantages
-
Not all debts qualify for consolidation. Those who need to use consolidation most -- those with high interest rates and monthly payments -- may not have the credit score necessary to get the consolidation loan at an interest rate that would garner any real savings. By drawing out the loan term, you may pay more in interest if you consolidate debts that have only a few months or years to their payoff date. Sometimes creditors close the accounts you pay off, truncating your credit history and thereby lowering your credit score. You may lose perks you had with your old lender, such as discounts for paying on time. You also may lose the right to ask for a reduction in your balance (settlement).
The Bottom Line
-
Debt consolidation is not a true method of reducing debt -- your new loan must at least cover the principle balances of any debts you're incorporating. Unless you can get a lower rate of interest, consolidating may not help. Don't include any debt that has a lower rate of interest than the one given in the consolidation loan. You must check that extending the time you'll be paying on the debt doesn't negate the savings you get through the lower interest rate. You also should be clear with your old lenders that you'd like to keep your accounts open when you pay them off. If you want to consolidate and have just applied for other lines of credit, wait a few months so your credit score doesn't go down from having yet another account.
In general, debt consolidation is better for those who haven't gotten into serious financial difficulty yet. Use it if you can't organize your money well because of the sheer number of debts, or if you need more disposable income available per month. After consolidating, don't fall into the trap of thinking you can spend the way you did before consolidation -- be serious about removing the habits that got you into debt in the first place.
If debt consolidation won't work for you, you have other options. The first to try is negotiating with your lender. Sometimes you can get a better interest rate just by asking. If that doesn't work, refinance. Tapping into home equity or approaching friends for small loans also can get you back on your feet. The next step is to look at debt management, resolution or settlement. The last option is bankruptcy. Bankruptcy puts a serious ding in your credit and makes future financing harder to get, so don't go this route unless you've tried everything else.
-
References
- Photo Credit Jupiterimages/BananaStock/Getty Images
