Lowering debt payments by rolling them into one, nicely packaged deal seems like a good idea, right? While consolidating debts can be beneficial in certain situations, it should by no means be the default measure for anyone looking to resolve their debts. Here’s why:
You are taking out another loan — most people don’t realize that debt consolidation comes in the form of another loan. The reason you are able to make one payment is because that payment goes to the lender who is essentially paying, or has paid off, your prior lenders. In some cases, you may even be required to take out a second mortgage or home equity loan in order to secure the consolidation loan. This creates big problems down the line if you were to default on the paying your consolidation lender.
The terms of the agreement can be outrageous – debt consolidation loans may roll everything into one payment, but the terms and conditions of the loan can be less favorable than your prior debts. Higher interest rates and steeper penalties for defaulting are just two of the common terms found among consolidation loans. Is paying a higher interest rate on a consolidated debt total really worth the convenience of having all your payments rolled into one?
Debt repayment can take far longer — when individuals debts are consolidated into one payment the interest rate is applied to a single, much higher balance. Interest paid on a single higher balance will cost you far more in the end. The higher interest rate also means you are paying less towards the principal debt owed each month, taking you longer to pay off the debt completely. Other options, such as credit negotiations, may be able to lower you debts directly with creditors in a shorter amount of time than through debt consolidation.