Debt Consolidation- Is It An End All Solution to All Your Debt Woes?

If you have several high interest loans, combined with a good credit score, then debt consolidation may be a good idea. A good credit score enables you to qualify for a lower interest rate. Otherwise doing a debt consolidation doesn’t make sense. If you tend to overspend and assume more debt, then a debt consolidation doesn’t make sense. For instance, if you do a debt consolidation and go on assuming more credit card debt, then the debt consolidation becomes a vestigial process.

Some reasons why you should avoid debt consolidation include the following:

There are significant risks and tradeoffs with this strategy:

• Upfront Costs: The process of debt consolidation includes new, upfront costs like origination fees, balance transfer fees, closing costs and annual fees. When taking your decision to consolidate your debt, make sure that you factor in all such additional fees and costs. These entail the true costs of debt consolidation and must not be missed in your reckoning before you sign on the dotted line.
• Low Credit Scores: You may be among those who are financially indisciplined and not have a good credit score, As the very purpose of doing a debt consolidation loan is to enjoy low interest rates, low credit scores will mean your interest rates will remain stubbornly high. You may also end up with interest rates which are higher than your current average interest rates. This plus higher front-end costs will mean higher overall charges. All individuals with poor credit histories and high debt levels may even end up paying higher rates of interest which negates any saving benefit from lower interest rates.
• Higher Absolute Interest: You will pay higher absolute amount of interest after consolidating all your loans over time. Payment of interest starts from day one and may extend up to 7 years in total. Monthly instalments may be lower but interest payments will extend for a longer period. If you make large loan instalments payments every month, you can reduce your future payables. A prolonged payment period will mean that your other financial goals like saving and wealth accumulation may be delayed further.
• Missed Loan Payments: Any missed loan payment means a major issue in terms of your deteriorating credit score. This may also mean added fees. You can of course avoid such situations by using autopay. Doing this means you do not need payment reminders. Make sure that you communicate any missed payment to your lender/loan originator promptly.
• Financial Prudence: Debt Management requires a large amount of financial prudence and discipline. You may fiscally imprudent and liable to spend large amounts without adherence to your budgets. Debt Consolidation does not make you financially prudent or practice fiscal restraint. It only restructures your debt into a more manageable form. After all, remember that it is your spending habits that got you into debt. Accumulating more debt like new credit cards and personal debt will push you further into indebtedness. If you miss a single instalment payment, your lending institution will report you to the credit bureaus. This will make it difficult for you to qualify for future loans.
• Risk of losing collateral: You may have secured loans like home equity loans which are secured by a lien of your home which is mortgaged. Under debt consolidation, where you miss making some instalment payments, you run the risk of losing the title to your home upon default.
• False Sense of Financial Relief: Debt Consolidation creates a false sense of financial relief. When faced with a single loan instead of a multitude of loans, you may feel that your debt burdens have lifted. Without changing your spending behaviour and financial prudence, debt consolidation cannot succeed. You must address the root cause of debt accumulation.
• Limited Access to future credit: Consolidating all your debts by closing old loans and taking on a larger new loan will adversely affect the future availability of credit. You may be able to access credit only on less favourable terms than before.