Debt consolidation is the process of taking a new loan to pay off smaller debts. This means, multiple loans are combined in to a single larger piece of loan, usually with a lower interest rate or a lower monthly installment. Debt consolidation can be used to deal with huge credit card bills, student loans, medical loans or any other personal loans.
People generally prefer to consolidate their credit card payments by using the balance transfer feature. This benefits the consumer especially if the new card comes with a 0-annual fee and lesser APRs.
Debt consolidation has its own pros and cons. As a customer, you should meticulously evaluate the consequence of consolidating your debts and take an informed decision. It can be a great setback if financial decisions are not carefully planned. Debt consolidation may seem to be appealing, but it is important to understand why it may not be a good idea.
When to say no to debt consolidation?
Here are a few points for you to check why consolidating your debts might not really help.
- You don’t change your habits – The main reason behind consolidating your debts is to find some breathing room and thus finding some extra money in your pocket. If you are a spendthrift and use all your extra money in buying stuffs, debt consolidation will hit you hard. In this case, you will delay your debt problems, instead of solving them.
- You end up paying higher interest rates – It does not make sense to pay higher interest rates towards a loan. Those with poor credit are often charged higher APRs. There is no point in paying more only to consolidate your debts. The first thing you should do, is improve your credit score and pay all your dues on time.
- You put your house in danger – People consider taking home equity loans as they have lesser interest rates as compared to credit cards. But using this as a tool to consolidate your debt can be challenging, as you will be converting your unsecured debt into secured debt and eventually put your house in danger.
- You don’t read the fine print – Debt consolidation comes with its own terms and conditions. If you are not aware of its hidden charges, penalties for late or missed payments and fluctuating rate of interests (if any), consolidating your debts will be a bad idea. Some banks come with an introductory offer. As a customer, you should know when this offer will come to an end and what will be the charges later.
Debt consolidation might seem attractive because of lower monthly payments and interest rates. But, the term gets extended, thus putting you in debt for a longer period. This means, although you pay less towards installments, you end up paying your lender more in the long term.
The two alternatives to consolidating your debts are debt management and debt settlement. Debt management is the process of approaching your lender and discussing your financial situation. Your lender might work out a debt management plan suiting your requirements. If you ask for a lower payment, your balance will be stretched over a longer term.
Debt settlement is consolidating your debts without borrowing money. This means, you will have to negotiate with your lender and ask them to allow you pay only some portion of the loan. Once you pay the settlement amount, the remaining balance will be forgiven. This is something you can do yourself, but you can also hire professional help if required.
It is important to sensibly think over the decision of debt consolidation, as taking more loans will pull you further down. Make sure to choose a solution that suits your financial needs.