Should You Consolidate Your Debt?
The Pros and Cons of Debt Consolidation Loans
If you're like most people, you need to figure out a strategy for paying off loans. While it would be a lot easier to just pay cash for most things, the reality is that most of us don't have several hundred thousand dollars lying around. Between mortgage payments, car loans, student loans and credit card debt, we need to have a clear plan for paying off debts — especially if we're responsible for a lot of different debts all at once.
Most financial experts might define debt consolidation as the replacement of multiple loans with a single loan, often with a lower monthly payment.1 Such loans also tend to offer a longer repayment period. So if you want to look at the pluses and minuses of debt consolidation for your personal situation, you might want to start by considering your monthly cash flow — and ask yourself the following questions:
- Is it better for me to pay back money I have to borrow in one big chunk on one single loan, knowing that I can take more time paying it off?
- Or is it better for my overall budget if I pay back several different loans to different entities and keep to a more regular payment plan?
- What about my credit card debt? Is it better for me to use just one zero/low-interest credit card to avoid high finance charges? Or do I risk financial trouble down the road if I build up too much debt on one single credit card?
Pros of debt consolidation loans
Pro #1 — When you opt for debt consolidation, you have only one creditor to pay, and that company will call your creditors and negotiate on your behalf. So when you get a debt consolidation loan, you can look forward to a certain amount of personal attention.
Pro #2 — Interest rates are usually pre-set by creditors, so the debt consolidation firm handling your loan can definitely get lower interest rates and reduce (or even eliminate) late fees better than you can.
Pro #3 — If you've had past credit problems, creditors are likely to hassle you less if you're working with a debt consolidation firm. If, for example, you do start to get calls from creditors, a reputable debt consolidator will often be willing to speak on your behalf.
Cons of debt consolidation loans
Con #1 — Debt consolidation is not for everyone. For example, when you go with a debt consolidation plan, you're required to stop increasing your overall debt, which often includes limiting the use of your credit cards. If you want to consolidate, many firms will ask you to stop using your credit cards altogether.
Con #2 — Like most loans, debt consolidators require collateral. The catch is that many debt consolidation loans are considered "unsecured loans," meaning that you can't negotiate a lower rate if you don't offer solid collateral in return. And even if you do have reasonable collateral to offer, it can be seized and taken from you if you can't otherwise pay back the amount you owe.
Con #3 — A debt consolidation loan can help you lower the interest rate on your credit card bills if you used a home equity loan or home equity line of credit (HELOC) to pay off the debt, but you could put your home at risk in the process — if, for example, you're unable to keep up with the payments. And if your credit history isn't in the best shape, that's not a good overall situation for you.
If you find yourself facing large debts, a different approach to financial management is clearly something you'll want to strongly consider. One option is a debt consolidation loan, but you need to research its impact on your specific situation before determining whether it's the right option for you.