By Andrew Housser
You are scared to look at your checkbook balance. You avoid opening bills. You are late on making payments to creditors, and paying high late fees and interest charges. If this sounds familiar, you might be considering debt consolidation. Essentially, debt consolidation combines all of your debts into one loan so you owe only one creditor. This idea might sound appealing, but it has its disadvantages as well as advantages. To determine if debt consolidation makes sense for you, take a look at these facts.
Fact #1: Debt Consolidation Alternatives Exist
There are several ways available to obtain funding to consolidate, and pay off, debts. One of them involves working with a debt consolidation firm. But individuals can consolidate their debts on their own, too, and pay off debt.
Fact #2: Debt Consolidation Is Not Right for Everyone
Debt consolidation works best for those who are able to pay bills but find it difficult to juggle multiple bills or remember payment due dates. For those struggling to pay bills at all, or who have bad credit, many debt consolidation options may not present the best options. Those individuals can talk with a debt relief counselor to figure out alternatives.
Fact #3: You Could Lose Your Home
Some people look to refinancing or borrowing against their homes as a route toward debt consolidation. Refinancing and taking cash out at closing can help pay down high-interest debt, and can be tax-deductible, but carries risk. Make sure that there is no possibility of missing a payment, because you don't want to face a foreclosure because you transferred too much unsecured debt to secured debt. (Unsecured debt is not backed by any type of collateral or asset, and includes debt from credit cards, medical expenses and utility bills.)
With a home equity loan or line of credit, you borrow against your home's equity in order to take out a loan to pay off creditors. However, in order to secure this type of loan, you have to put up your house as collateral. Essentially, you are taking out a second mortgage on your home. This means you could lose your home to foreclosure if you are unable to make payments. Plus, if your home's value drops, you may not be able to pay back all the money you owe if you need to sell your home.
Fact #4: A Personal Loan Can Be Costly
If you are not a homeowner or do not want to risk your home, you may be able to take out a personal loan to pay off creditors; this, too, is a form of debt consolidation. This option requires you to have a strong enough credit rating to qualify for a good interest rate without any collateral. The problem is that it is difficult to get a personal loan with a low enough interest rate. Often, you may be better off just continuing to pay your creditors.
Fact #5: Using Another Credit Card Is Risky
A popular way to consolidate credit card debt is to transfer debt to a zero- or low-interest credit card. If you have good credit, this may be possible, but remember that the great rate will not last forever. Make sure you know when the introductory offer expires and what the new rate will be. Keep in mind that this rate will increase if you miss a payment or are late. Most importantly, do not continue to charge on your other cards once you have consolidated your debt. And do not use the new card to make new purchases.
Fact #6: Debt Consolidation Services Do Not Eliminate Debt
Debt consolidation services ask consumers to make one monthly payment, which then is used to pay creditors. Consumers pay back 100 percent of the debt, plus interest. If the problem is too many accounts with too-high minimum payments at crippling interest rates, these services may offer a solution. They can be helpful to people who are sure they can change their habits, so that they can focus on just one interest rate and one payment.
However, these loans are usually secured by the borrower's property, such as a home or car, which puts those items at risk if the borrower cannot pay. Fees can be high. Many services have poor histories and reputations. Those working with a debt consolidator will likely sacrifice the freedom to open and use additional credit lines and, in many cases, their credit profiles. In addition, you can only consolidate unsecured debt.
Fact #7: Consolidating Debt May Cost You More in the Long Run
A debt consolidation loan – whether from a debt consolidation service or other – often gives you additional time to repay the loan. This might sound good. In reality, this means that you could pay more interest over the life of the loan even if you have a lower interest rate and make lower payments than when you started. Also, you could face costly penalties and see your interest rate increase if you are late with a payment, or miss one.
Debt consolidation can simplify on-time payments for some people. But it does not address issues like overspending and poor budgeting – issues that, for many people, created the original debt problem. If you choose debt consolidation, you must also turn over a new leaf and avoid adding to the mountain of debt, or you risk doubling your debt instead of eliminating it. Either way, think carefully before opting for debt consolidation.
Andrew Housser is a co-founder and CEO of Bills.com, a free one-stop online portal where consumers can educate themselves about personal finance issues and compare financial products and services. He also is co-CEO of Freedom Financial Network, LLC providing comprehensive consumer credit advocacy and debt relief services. Housser holds a Master of Business Administration degree from Stanford University and Bachelor of Arts degree from Dartmouth College.