There are few things in life as disappointing and distressing as multiple debt accounts. When you are stuck with a lot of debts, the interest you pay sucks away all the money that should be going to reduce your principal. One of the ways to overcome this difficulty is through debt consolidation.
“Debt consolidation is a great option for consumers wanting to reduce their outstanding debt and change their spending habits,” says Susan Hoefs, the Lending Director at Montgomery County Employees Federal Credit Union.
The key, though, is making sure that you use debt consolidation to your advantage. If you aren’t careful, you could end up getting into more trouble with debt.
Debt consolidation choices
When using debt consolidation, you normally have two options to choose from:
- Debt consolidation loan: A debt consolidation loan involves getting one large loan and using it to pay off your smaller debts. With a debt consolidation loan, you end up with only one payment, and one interest rate. If you can manage it, your best option is when your debt consolidation loan interest rate is lower than the average of your disparate interest rates. “Consumers should carefully compare the rates and terms of the debt consolidation loan to their current rates and terms to ensure that the debt consolidation alternative is really going to help them achieve their overall goal,” says Hoefs.
- Non-loan debt consolidation help: Another possibility is to get non-loan debt consolidation help. In these cases, you aren’t required to borrow money to make things happen. Instead, you get the help of a third-party to make your payments. You make one payment to the third-party, and they manage your payments to creditors. In some cases, this type of debt consolidation comes with debt settlement, in which you pay less than you owe. Other programs simply negotiate lower interest rates so that your payments reduce your principal at a faster rate.
In either case, it’s important to check for fees, and consider the implications of your decision. Many consumers use their home equity for debt consolidation loans because it is often tax deductible and the interest rate is usually lower. However, this move puts your home at risk. If you end up unable to pay, your most valuable asset is at risk of repossession. An unsecured debt consolidation loan can mean that you don’t risk your property if you run into trouble.
Even if you choose an unsecured loan, you need to watch out for some of the consequences. First of all, since you have paid off your credit cards, you need to battle the temptation to use the cards again, running up more debt. However, closing the accounts might not be the best option if you are concerned about your credit score. “Consumers opting for debt consolidation loans often close out all their credit cards so the temptation to use them is eliminated,” points out Hoefs. “What many don’t realize is that closing the accounts can have a negative impact on their credit score.”
Non-loan debt consolidation should also be carefully considered. If the result is debt settlement, you could see a big hit to your credit score before the process completed. Debt negotiation and settlement requires that you stop making payments to creditors in order to force them to accept a smaller amount than you owe. While this can be effective, the reality is that it means a lot of missed payments reported on your credit history, not to mention the notation that you settled your debt rather than pay the entire amount you owe.
Change your habits
The biggest thing you need to do in order to make sure your debt consolidation is done to your advantage is to change your spending habits. Debt consolidation can take care of the symptom of your problem. However, you have to remember that the debt is the symptom — not the cause. If you want to stay out of debt for the long haul, you need to identify the financial habits that led to your debt.
Review your income and expenses, and identify where you have been overspending. Change the way you view money, and the way you use it. Before you consider consolidating your debt using any method, you need to stop spending more than you earn and get your budget under control. Once you have done that, and you have a handle on your income and expenses, then you are more likely to be successful with your debt consolidation efforts.
“Debt consolidation can offer many advantages such as finance charge savings, a reduction in monthly payments, and the ability to pay off debt within a specified term,” says Hoefs. However, without a fundamental change in your financial habits, debt consolidation is only likely to have short term effects. Long term, you are likely to end back in trouble.