Although I generally don’t recommend debt consolidation loans, I admit that there are times when such a loan can help. For example, if you have lost your job and the wolves are at the door, consolidating your debt can lower your payments and get you some room to breathe while you are getting back on your feet.
However, in my thinking, it is usually not your best decision. The allure of the programs to consolidate debt is that you can lump all your debts together and have a lower monthly payment. This may be true, but in most cases it is still a bad idea for the following reasons:
Reasons to Not Do a Debt Consolidation Loan
- You get a false sense of accomplishment that you did something about your debt. You didn’t! You still have the same debt; you simply moved it.
- You are told that debt consolidation will save you interest. This is not always the case. Why? Because lower rate debts are often consolidated with the higher rate debts. If your monthly payments are lower as a result of the loan, you have probably agreed to stretch the debt out over a longer period of time. BAD IDEA! Your goal is to get out of debt, not prolong it.
- You have dealt with the symptom, not the problem. The symptom is your debt; the problem is that you are not good at handling money. 78% of people who take out debt consolidation loans build up new debt (usually credit card debt) and end up much worse than when they started. You need to ask the person in the mirror why he is in this mess.
“But Joe,” you may be thinking, “I have checked the numbers and I am really saving on interest. I can get my payments reduced and still not stretched out over a longer period of time.”
Maybe so. But I ask, “Saving interest compared to what? Minimum payments?” I am still concerned about the false sense of accomplishment and the ensuing tendency to create new debt. The better you can learn to manage your money, the faster you can get rid of this debt. And the faster it goes away the less interest you will pay. Think in terms of time (how fast can I pay this off?) instead of interest rate.
Problems of Debt Consolidation Loans
So how do you go about dealing with the problem instead of the symptom? It is essential that you create a budget. On one sheet of paper write down your total monthly take home pay. On another write down all of your monthly payments and expenses. Look it over for a couple of days because if you are normal you are probably leaving something out. Hopefully, the income total is larger than the outgo total. If so, you know how much extra you can pay on debt every month. If not, you know what you are dealing with and you need to either raise your income or lower your expenses until you have enough positive cash flow to attack your debt.
Now you can use the debt snowball, using all of that positive cash flow on your smallest debt while making minimum payments on all other debts. Once that first one is paid off, roll the payment amount, along with the minimum payment, into your next smallest debt. You will gain momentum as you see these debts disappear and you will actually be accomplishing something: paying off debt! You will have changed the way you manage money, hopefully for the rest of your life. And you will have something most “normal" people in the USA don’t have: MONEY!
Readers: What do you think? How have debt consolidation loans worked for you? Do you know of anyone who has ever used a payday loan?