The Truth and Myths of Debt Consolidation

If you’re dealing with a huge amount of high interest debt that is crushing you financially, you’re not alone. Millions of Americans have credit card debt, personal debt, private student debt, even high interest auto loans and mortgages that are absolutely burdening to a financial future.

There is a common solution to this, though, and that is debt consolidation.

What is Debt Consolidation?

Debt consolidation is a service offered by banks and lenders that aims to lower interest payments for the borrower. It’s simple: the debt consolidation company will lend you a sum of money as an installment loan. You, with the help of the company, use that cash to pay off your high interest debt in one fell swoop.

what is debt consolidation

Then, you pay down the installment loan according to the terms.

What are the benefits of debt consolidation?

The benefits of debt consolidation are clear. First, you can get lower payments and lower interest rates, possibly allowing yourself to get locked into a lower rate and avoiding a high adjustable rate.

This allows you to save a considerable amount of cash over time. Imagine paying half of your current debt payment right now, for a shorter time than you needed to! That is the power of debt consolidation.

benefits of debt consolidation

Second, it may help your credit directly if you are paying off something that is past due, or if you are underwater on some debt.

Consolidated debt can also be cleared in bankruptcy, as well. This is one reason you might want to consolidate high interest student debt.

What are the risks of debt consolidation?

Debt consolidation is not without its risks, however. First of all, you’re locked into an installment loan with a debt consolidator. This loan must be paid on time and often cannot be postponed.

Student loans, for instance, can be put into forbearance and even deferred due to extenuating circumstances. By consolidating your debt, you lose that benefit. You must pay that debt, otherwise it becomes past due and could go into default.

Credit card debt often has minimum payments which are quite low compared to the amount of debt you have. Debt consolidation has one payment required every month, and that payment may be much higher than your credit card minimums.

Risk of Debt Consolidation

Another risk is that debt consolidation is likely to hurt your credit in the very short term, making it hard for you to get more debt. But this effect goes away over time. It’s also likely to improve your credit very quickly, as you can pay more of your debt down faster.

Debt consolidation is not without its costs, either. They usually require origination fees, which can be up to 5% of your total debt! Not all debt consolidation services require this fee, though, so do your research and make sure you understand all the costs!

There are also late fees for not paying on time, penalty interest, and cancellation fees if you decide to close out the account.

Should I consolidate my debt?

Some banks will offer debt consolidation services to you at a low rate. If you can do this to your credit card debt or high-interest personal debt, this may be a wise decision.

should i

This should not be confused with a balance transfer. A balance transfer is when you take your credit card debt balance on one card, and transfer it to a lower interest rate card. Most banks offer this service, and some even include with a 0% APR for a short period.

Overall, you should consolidate your debt if:

  1. You can afford the quoted payments over that period of time
  2. You will get a lower interest rate, allowing you to pay less over the life of the loan