Lately, I’ve spoken to many individuals and couples that have chosen or are thinking of choosing to consolidate their debt. These people are facing a large amount of debt. They are sick and tired of being in debt and are ready to take the steps to get rid of it. They have heard that debt consolidation can reduce their debt and reorganize it so they can pay it off faster and/or it’s the only way to get out of debt. Therefore they believe that debt consolidation is the answer to their debt problem. This is a myth.
What is Debt Consolidation?
Debt consolidation is a personal finance process of individuals addressing high consumer debt. It is a form of debt refinancing that entails taking out one loan with one monthly payment to pay off several debts with the illusion of a lower interest rate, lower monthly payment and simplified debt-relief plan.
Debt Consolidation is not the answer to your Debt Problem
Debt consolidation doesn’t mean debt elimination. You still have debt and the behaviors that got you into debt.
Your Debt Still Exists
A misconception of debt consolidation is that it eliminates your debt, but you cannot get out of debt by creating more debt. By combining all your debt and putting it into one basket doesn’t make the debt go away, you still have all the debt. It was just moved.
You Didn’t Change Your Spending Behavior
Debt consolidation is dangerous because you only treat the symptom of the problem. You may feel an emotional and financial relief, but it is a false hope and could leave you feeling prematurely confident about your financial situation. This might cause you to let your guard down and incur additional debt before you have paid off the consolidation loan, starting the cycle all over again. Most of the time, debt will continue to increase in your life even if you do the debt consolidation. It’s because you are not actually creating a plan to change your money management and financial habits you are just moving the debt somewhere else. Most people take on more debt after consolidating or end up in bankruptcy because they didn’t change their behavior.
One Payment Will be Easier to Manage
Debt consolidation will leave you with just one monthly payment rather than several. The theory is that one payment will be easier to manage. Of course only having one bill to pay rather than 4 is way easier to manage, but is paying bills the problem? With online bill pay you can pay all your bills at the same time within 5 minutes. Paying the bills is not the problem, the struggle comes from not knowing how you are going to pay the debt off and how long will it take.
How Does Debt Consolidation Really Work?
Let’s say you have $30,000 in unsecured debt—think credit cards, car loans and medical bills. The debt includes a two-year loan for $10,000 at 12% and a four-year loan for $20,000 at 10%.
Your monthly payment on the first loan is $517, and the payment on the second is $583. That’s a total payment of $1,100 per month. If you make monthly payments on them, you will be out of debt in 41 months and have paid a total of $34,821.
You consult a company that promises to lower your payment to $640 per month and your interest rate to 9% by negotiating with your creditors and rolling the two loans together into one. Sounds great, doesn’t it? Who wouldn’t want to pay $460 less per month in payments?
But here’s the downside: It will now take you 58 months to pay off the loan. And now the total loan amount would jump to $37,103.
So, that means you shelled out $2,282 more to pay off the new loan—even with the lower interest rate of 9%. This means your “lower payment” has cost thousands more.
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References:
https://www.daveramsey.com/blog/debt-consolidation-truth
https://www.nationaldebtrelief.com/debt-consolidation-work-much-cost/
https://www.nolo.com/legal-encyclopedia/debt-consolidation-pros-cons.html
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