When is Debt consolidation a good idea?
For debt consolidation to work:
- The interest rate on your new debt must be lower than the debt you are consolidating.
- A lower interest rate will lower the amount of money you have to pay each month.
- Pay off the new debt as fast as possible.
- You do not take on additional debt until you pay off the new debt.
Consolidating your debts into a single payment also is more convenient. No longer do you have to write 5 different checks with 5 different due dates. Now you make a single payment when it’s due. This also limits the chances of late fees and less damage to your credit report.
Keep in mind if you consolidate your debt, you may end up falling behind if you stick to your old habits. Many people will continue to spend or feel they have money to spend because they feel they have things under control with a lower payment. Debt consolidation makes no sense if you do not change your spending habits.
There are several options to consolidate your debts. They include:
- Getting a loan from the bank.
- Transferring the balance from a high-interest credit card to a lower interest credit card.
- Borrow money from your whole life insurance policy.
- Borrow money against your home equity
- Borrow money from your retirement account
- Borrow money from friends/family
You may have to talk to a CPA, financial advisor, or a reputable nonprofit credit counseling agency to determine what the best option for you is.
Dangers of Debt Consolidation
There are many companies offering debt consolidation services. If you are not careful, you can be taken advantage of because many of them have very high fees or are just scams. Their goal is not to help you but to get your money.
Avoid debt counseling companies that promise to lend your money to pay off your debt. These companies offer high-interest loans that you must secure with your home. If you default on your loan, they will take your home.
Avoid finance company loans that use advertisements to entice you by claiming they have the solution to all your debt problems. These companies normally have high-interest rates and very high fees. Additionally, working with a finance company will damage your credit report.
Avoid lenders who offer substantial loans with no questions asked, in exchange for you paying a big upfront fee. No reputable lender will make such a promise. These lenders will sell you a high-interest loan and place a lien against your home or other important assets you own.
Avoid companies that promise to negotiate a debt consolidation loan for you to pay off your creditors. They will tell you initially to pay them each month to repay the loan. However, they will never get you a loan or pay off your creditors. They in a sense will just steal your money and ruin your credit.