Is Debt Consolidation Bad?

Millions of individuals and families in North America are in debt.  Whether you want to analyze good debt or bad debt and the merits of classifying debt one fact remains indisputable – people have over extended themselves to the point they can’t manage their debt, and they need help. Whether their credit cards are maxed out or they are having issues paying their university student loans back debt has snowballed for quite a few people who could use some debt help.  A lot of these people are likely wondering: is debt consolidation bad?  As usual the answer to this question is subjective and in this writers opinion each individual scenario is different just as each individual is different.

So is debt consolidation bad?  Lets look at the upside and downside of debt consolidation.

Is Debt Consolidation Bad?  The Upside

  • LOWER INTEREST RATE!  Those high interest loans consolidate under one lower rate.  Lower interest means …
  • One singular lower monthly payment.  This will result in fewer bank fees and chances of missing payments.
  • Speaking of fees, the company representing you may be able to get your creditors to drop some late payment fees.  Personally I detest “fees” be it ATM fees, late fees or PayPal currency exchange fees.
  • You now have one creditor that you deal with.   Less debt to keep track of and fewer creditors to interact with.  Could this lead to less stress?
  • Since you have one creditor the collection agencies should stop calling you incessantly.
  • Once your debt is being actively dealt with some creditors may forgive your credit rating decreases.  Improving your credit rating is pretty important and paying off your debt will help remedy a poor credit rating.

Is Debt Consolidation Bad?  The Downside

  • A debt consolidation loan is a secured loan.  This means that you need to “secure” the loan against something of value such as a vehicle or a home.  This can be a scary proposition for some individuals.
  • Loan term length.  If you get a debt consolidation loan that persists over many years you will be paying off the debt for the agreed to term.  This could lead to paying more interest over time against the debt than if you had not consolidated in the first place.
  • Debt consolidation means you are signing a legally binding contract.  Contracts have many clauses in them.  If the borrower doesn’t take the care and caution to read and understand the loan they could end up paying balance transfer fees and/or application fees.  This adds to your debt.
  • The borrower may rack up more debt.  A poor financial plan might have gotten the individual into debt and lowers payments could lead the borrower to spend, or worse, borrow more money if they continue as they had.

It appears that there are some potential pitfalls one could encounter if they consolidate their debt.  The individual has to change their financial habits and fully understand the legalities involved with taking on debt consolidation. Those who take the benefits of debt consolidation to heart and don’t worsen their situation by acting irresponsibly while also educating themselves on the new agreement they are entering could do well consolidating debt.

This brings us back  to the original question: is debt consolidation bad?  Depends.  There is a load of potential for someone looking to turn their financial situation around but also some risk for those unwilling to do the same.

18 comments to Is Debt Consolidation Bad?

  • I would personally look at a debt consolidation loan as a last resort. It’s definitely a good idea if you don’t have other options to lower your interest rates and just can’t keep up though.

    For homeowners with some equity in your house, the first action to take would be to get a home equity line of credit and use it to pay off your high interest debts. Just make sure you don’t rack up more debt in the process.

  • I see debt consolidation as a decision that one has to think about, analyze carefully and work through slowly. Refinancing a mortgage to get a better rate isn’t ALL that different a concept. You are taking into consideration some potential penalties and downside to reduce the amount you pay now, and possibly pay later.

    You need to understand the fees, if any. And understand how term can affect the total interest paid.

  • Great post SPF. I have to admit that years ago I did use a consolidation loan. I was however very responsbile with paying it off and once I was debt free I remained that way. It can be a good thing if you do it right just like you mentioned.

    PS: Congrats on breaking the 400 reader barrier!

  • Thanks for the compliment, Miss T. Used properly these loans can really help someone down on their luck.

    We hit 400 readers earlier in the week but then fell, and rose, and fell and rose … It will take a bit to stay above the mark consistently!

  • Fascinating, I’ve heard so much about this and seen it advertised everywhere so it’s good to actually hear the ins and outs of debt consolidation. I’m fortunate enough to not have any debts, but it’s good to be informed, especially since I have friends who are trying to tackle their debts effectively.

  • I have to agree with Saving Mentor, the debt consolidation is one of the final options to explore when overwhelmed with debt. I agree that one major downside is that you are taking unsecured debt and securing it, that’s risky. Before any of this, the borrowers have to be certain they are not simply going to rack up more debt. I like your descriptions of the pro’s and cons.

  • Like most things in the personal finance world there is no black or white. Debt Consolidation could be a GREAT thing for someone that needs it. Just like a payday loan might be a better option than defaulting on a debt or overdrafting.

    Way to stay fair and balanced!

  • I think that this – like many/most things in personal finance depends on the person, the situation and many other factors. Blanket statements here aren’t a good idea.

    • @Jeff – do you think I made a blanket statement here?
      @Evan – thanks, I was striving for showing both sides of the coin.
      @Hunter – All financial decision require a delicate touch – and research!
      @Shannon – glad I could shed some light on the topic for you. Great on you for not having any debt! Have you eliminated a mortgage as well?

  • Ben - BankAim

    As SavingMentor said, I would use this service as a last resort. There are many other ways you can get out of debt, if you made an honest effort. I understand that there are many different circumstances and problems people face that could cause them to struggle with getting out of debt. My sister had to go this route and its been hard for her, but she is getting out of debt. For me, I used my own credit cards to consolidate debt, by transferring to a 0% interest for 18 months and then paid down the debt without worrying about paying interest for 18 months. This helped me get out of debt much faster than if I used a company, which would have initially added to the debt.

  • DebtManagement

    Interesting article with different option! If you forget this idea for a minute then concentrate on the other options, if you have any other expensive thing in home like gold jewelry or any other thing. You sell it and get out of high interest rate. If you don’t, then check second option barrow money from your relatives or friends. then the last and the best option is debt consolidation loan.

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