Issues with debt ‘consolidation’

By | 5th June 2017

Issues with debt 'consolidation'

Sadly debt ‘consolidation’ is an area where people can stumble if they are not careful.

The key point to remember with consolidation is that nothing has changed – you still have a pile of debt, but now instead of several different lenders it is all with one.

There should only be one reason for doing a consolidation – to reduce the interest rate you are paying on the debts, so that they can be paid off sooner.

Doing a debt consolidation to reduce your monthly payments can come back on you, actually resulting in a higher total interest amount being payable even at a lower interest rate. (Because the term of the payback is extended – a good worked example can be seen in this post on debt consolidation by Dave Ramsey.)

The further danger with consolidation is that spending habits may not change – sometimes people are looking to consolidate and also include a new debt within the total. Perhaps they want that luxury holiday/car/etc. and including it within the consolidation seems a good idea.

However you need to remember that you haven’t ‘paid off your debts’ or ‘cleared your debts’ with a consolidation – they are still there, and as mentioned could cost you more in the long-term if the repayment period has been extended. So adding new ones to the total isn’t a good idea.

It’s far better to clear the existing debts first before looking at new purchases – and ideally those new purchases should be paid for with cash savings so that future debts are avoided.

The final danger with consolidations is that people don’t actually use them to pay off and close the credit facilities they were meant for.

A percentage of people find that, a few years later, they not only have a big consolidation loan but have also run up their old credit facilities again as well – doubling their debts.

If you have a set date goal of becoming debt free and find that a consolidation loan can help you achieve this earlier then they could be of assistance, but you need to be aware of all the dangers beforehand as they are not without risk.

James McBrearty started his own business from scratch in 2006, to help the self-employed.

He helps people to escape from the corporate world and shares his thoughts here on the changing world of work, technology and personal finances; as well as the occasional travel post.

Over the next 10 years things are going to change significantly. James is a follower of frugality and minimalism; and an advocate of F.I.R.E. to minimise the coming disruption.

Leave a Reply

Your email address will not be published. Required fields are marked *