Debt consolidation can be a smart strategy when properly employed. Its advantages are many, including a more affordable monthly payment, a lower interest rate and fewer bills to manage each month. However, like every other tool, one must wield it with care, lest the problem you’re trying to solve becomes worse instead.
Here’s some practical advice for avoiding common debt relief traps to help ensure that doesn’t happen to you.
Operating Without a Spending Plan
One of the first things you’ll need to do is ensure you can make the payments on the consolidation loan — while meeting your living expenses, putting cash away for an emergency fund, saving for your future and investing. This might look readily doable at first glance, but what if your car needs work, your washer conks out, or a family member has a medical emergency? Will you be in a position to handle those issues while maintaining the consolidation loan?
Consolidating the Wrong Debts
You have to be careful to ensure you don’t inadvertently raise your average interest rate when you accept the consolidation loan. While this can happen most often with credit card transfers, any consolidation schema should be viewed through the same filter. Along these same lines, be careful to factor in loan processing fees, transfer fees, or application fees as well. All of these can make the consolidation more expensive than it might appear to be at a glance.
Trading Unsecured Debt for Secured Debt
Along these same lines, you generally want to avoid taking a home equity line of credit or refinancing your home (secured debt) to consolidate credit card debt, medical bills and personal loans (unsecured debt). After all, if you’re forced to default on credit card debt, a personal loan or medical bills, the worst thing that can happen is a reduction of your credit score. Meanwhile, you can lose your home (and your credit score will drop) if you’re forced to default on a home equity line of credit or a refinance.
Continuing the Same Spending Habits
After consolidating your credit cards, the affected accounts will have zero balances. This means they’ll be sitting there tempting you to go out and spend again. However, you’ll soon find those accounts charged up again and you’ll have new bills to go along with the payment you’re making on the loan if you go right back to your old ways.
In other words, credit card consolidation does not eliminate your debt — it just moves it around. Yes, you can get a lower payment and you’ll be liable for less interest overall, but you’ll still owe that money.
Going Straight to Consolidation
As good as this strategy is, there are a number of other approaches to dealing with burdensome debt. Sometimes availing yourself of the services of a good credit counselor will help you see a way to handle your obligations without creating a new one. The other thing this will do is help you get to the “why” of your problem. This is key if you’re to avoid going through the process only to need it again in a few years.
You’ll find these tips to be more than useful when it comes to avoiding common debt consolidation traps. Creating a spending plan, being careful to consolidate the right types of debt and breaking your old spending habits will help make consolidation work for you. Failing to do any of the above could land you right back in the same predicament in which you’ve found yourself — and owing even more.