The ads run on TV all day, and the cheerful voice on the radio promises to help with debt through consolidation. It sounds fancy and can seem like a life preserver when someone is drowning in debt. However, it is important to know what debt consolidation actually is before signing up for it, and to know what it can and cannot fix.
What Is Debt Consolidation?
Many bad financial decisions have been made through not understanding what was happening. So, what is debt consolidation?
A debt consolidator will lend customers the money to pay off their other debts – student loans, credit cards, cars, mortgage, etc. – and set up a new term and interest rate to pay the debt back. That leaves only one company that needs to be paid and one number to keep track of.
This should not be confused with debt settlement. Debt settlement involves a company negotiating on behalf of the indebted to reduce the amount that is owed. This is a far riskier operation and can lead to high fees and loss of agency. Be sure to read the fine lines in the contract before signing it.
There are some positives to debt consolidation. The first positive is the convenience itself. Rather than having to juggle nine or ten different payments and payment plans, there is only one amount and one phone number to remember.
Often, the interest rate is lower than the previous debts, and the premiums are almost always lower per month. So, if the stress of the process itself has been a real problem, then debt consolidation could be a viable option.
Debt consolidation sounds too good to be true, and for many people that is exactly the case. At its worst, debt consolidation becomes a “short-term gain, long-term loss” situation.
While the interest rate is usually lower than the other payments and the monthly payments are also lower, it is almost always the case that the term (the total length of payment) is longer. Add up the total amount that will be paid, and the consolidated debt will be more than what was owed before.
It should also be mentioned that the customer rarely has control over what interest rates are offered or what the payments will be. The consolidator is going to make money off of the deal, so it is important to figure out how before signing on the dotted line.
The Bottom Line
There is one crucial function that debt consolidation cannot do: it cannot change a person’s spending habits or ability to handle money. Behavior drives most of a family’s financial situation.
If there is a strict plan in place to pay the monthly premiums (and then some), and restrict spending, then debt consolidation can work. But the money still needs to be paid back, and it is easy to be lulled into thinking that there is money “to burn” once the payments drop down.
Above all, do not make an emotional decision out of fear or anxiety. Crunch the numbers, talk to trusted friends, and speak to a qualified professional.