Debt consolidation loans may seem like a an almost ideal way to escape your current debts by rolling them all into one large loan, usually at a lower interest rate. If you’re trying to get out of debt, a consolidation loan may be part of the way to reach that goal, but just rearranging your debt doesn’t make it go away — and sometimes the lower payments you make on a consolidated loan mean you’re paying off debt for even longer, resulting in spending more on interest even with that lower rate.
Let’s walk through the pros and cons of debt consolidation to find out if a debt consolidation loan is a good fit for you.
Lower monthly payments aren’t as good as they seem
Debt consolidation loans sound like a sweet deal, promising to reduce both your interest rate and monthly payment; that is, until you realize the catch. To get that low monthly payment, you’re probably going to be paying off your loan for longer than you would have if you’d just kept paying your debts without consolidating them.
Even with a much reduced interest rate, a longer loan term may mean you’re paying more in interest over time. Before you sign up for a debt consolidation loan, be sure to do the math and figure out just how much you’ll spend in interest with your current debts and with your new debts — if the consolidation loan winds up with you paying more, it’s probably not worth it. Either way, you should talk to your financial institution at length to determine exactly what you’re getting in to.
Be wary of home equity loans as a way of consolidating debt
Taking out a loan on the equity of your home can seem like an easy way to get quick cash to bail you out of debt — and you can sometimes even use the interest on those loan repayments as a tax write-off. Please consult a qualified tax advisor for information regarding interest deductibility. But while this looks like an easy fix, it can put you at even greater financial risk if you aren’t careful. The biggest risk: that you could lose your home if you can’t make your loan payments.
While this can be a useful financial tool to pull you out of debt now, be sure you know what you’re signing up for when you borrow against the value of your home — and be sure you that can make the loan payments on time.
Changing how you spend and save is key to reducing debt
The biggest problem with debt consolidation is that it only addresses your debts — not the spending habits that probably got you into debt in the first place. If you’re looking to get out of debt, a consolidation loan with lower monthly payments may seem tempting, but if you continue to spend more than you can afford, consolidating your debt will only be a temporary fix… if that.
To get out of debt for the long term, you need to spend within your means and build a savings fund for emergencies — so you don’t run up expensive credit card bills when you suddenly need cash. If you’re consolidating your debts without making any other changes to your finances, it probably won’t get you out of debt — but on the other hand, if you’re a reasonable spender looking to consolidate debts you ran up during college, a consolidation loan could help.
Debt consolidation loans can help organize your debt
If you have lots of debt, large or small, to many different creditors; the biggest advantage of consolidating them is that you’ll wind up with a single bill to pay. With a debt consolidation loan, you don’t have to keep track of multiple interest rates and payment dates, which can really help simplify the process of managing your debt. For anyone who has trouble remembering to make payments on time, a debt consolidation loan can be a good way to go, if only for simplicity’s sake.
Just remember that a consolidation loan isn’t a magic fix. If you do take out a consolidation loan with the goal of reducing your debt load, you’ll need to change your spending habits to fit in with your goal of being debt free.