The idea of debt consolidation is pretty simple: combine a bunch of small (usually high-interest) bills into one bigger loan, with the goal of having a debt consolidation loan that offers a lower overall required minimum payment vs. the smaller ones combined. Debt consolidation companies aren’t all bad – they offer a truly marketable service. But can you borrow your way out of debt? Think about that for a moment. That’s what a debt consolidation is – a loan (borrowing money) to try to get out of debt. Let’s talk about three of the biggest pitfalls associated with this common method of getting out of debt.
Pitfall 1: Even the best debt consolidation loans are often in the form of a home equity loan. So…let’s say you do a credit card debt consolidation with a bunch of your small credit cards (unsecured loans), rolling them into one larger home equity loan (a secured loan). What you’ve done is shifted your debt from unsecured, where there was very little a creditor could do to you if you didn’t pay, to offering foreclosure on your home as an option if you don’t pay. That’s pretty scary.
Pitfall 2: Debt Consolidation only treats the symptom (usually). If a consolidation loan works as the companies all advertise, you should expect a lower overall monthly payment by rolling a lot of small bills together. That’s all well and good, but what caused all these small bills to start becoming an issue? Overspending is the real problem. Most of the time when you find some breathing room in your finances you end up deeper in debt because you don’t solve the problem. You only treat the symptom.
Pitfall 3: What happens if you can’t make that one bigger payment? It is a lot tougher in most cases to catch up if you get behind on one big payment than if you happen to miss a few little ones. The problem here is that especially if you’ve fallen into Pitfall 1, you not only have a huge payment you’re behind on, but it may very well be that your house becomes at risk.
As you might have guessed, the math of a consolidation loan makes sense. Remember though, the math isn’t the problem. It is the behavior that will cause you to win or lose with your money. Very few people can succeed with money when there is a lack of discipline, but I’ve seen dozens of people accomplish great things by simply renewing their focus and taking control of their money.