If you have a debt problem then one of the options that you will probably have considered is debt consolidation, where payments to lots of different creditors are replaced by a single (lower) payment for a loan that is big enough to enable you to pay off all of your other creditors. The debt consolidation loan can be either secured or unsecured and can result in a dramatic reduction in your monthly payments.
Advantage of Debt Consolidation for Your Debt Problem
The main advantage of debt consolidation is the reduction in your monthly payment for all of your debts. It is very important to prepare a realistic budget to make sure that your new reduced payments on your debt consolidation loan are affordable. Consolidation also makes your total debt situation clearer, i.e. you can’t fool yourself about the true total of all your debts. There is an administrative benefit to having only 1 monthly payment instead of lots of little ones, and if you had got to the stage of defaulting on any payments then the resulting letters and calls should stop when you pay off your account using the money from your debt consolidation loan.
Disadvantages of Debt Consolidation
If you use debt consolidation as a debt solution then you must make sure that you have sorted out the original problems that caused you to get into debt in the first place. If you don’t, you will quickly find that you have a debt consolidation loan AND lots of other debts, which would make consolidating your debt completely pointless and is a path that leads to severe debt problems and possibly bankruptcy.
If you take out a debt consolidation loan secured against your home (and I would usually advise against it) then you are making it much more likely that your home will have to be sold in the future. Unsecured creditors cannot usually force you to sell your home, whereas secured creditors can.
If you do enter a formal debt management solution after debt consolidation you will find that taking on an unsecured consolidation loan over a longer period than the original debts will effectively increase the amount of debt that you have, making it harder to get an IVA agreed with your creditors or extending the period of time that a debt management plan will take to clear your debts. This is because most debt solutions calculate your outstanding debt using the formula – Debt = Monthly Repayments * Number of Repayments left, e.g.
Credit card debt of £1,000 would be considered as £1,000 in an IVA or debt management plan. However if this credit card debt was payed off using an unsecured loan then the debt for IVA purposes would be (for a 7-year loan) 84 x repayment (roughly £22) equals £1,848.
Conclusion
Debt consolidation can be a useful tool on the journey towards a debt-free lifestyle. However you need to be certain that you have the discipline to keep paying the new loan and not create any more debts. If your income does not realistically enable you to pay the cost of your debt consolidation loan then there is little point taking it out. It will make the inevitable process of sorting out your debts properly much harder in the end.
September 18th, 2008 at 9:51 am
Everyone’s situation is unique but, if you do as much research as you can and use debt consolidation articles and other tools you find as a general guide, you can customize it to fit your situation.
September 21st, 2008 at 4:27 pm
It is a bad situation to get into in the first place, and it is good that you point that out. When I first met my wife, she was in a debt consolidation program where she combined 6 cards of 28%+ credit cards to one payment. That was good, but then she started to have to take out loans from Moneytree to pay the loan. Thankfully she told me this early!
September 22nd, 2008 at 8:47 am
Hi Hank
Thanks for stopping by, and I’m glad to hear that your Wife’s debt problems have been contained/resolved.
The key to getting/staying out of debt (and whether debt consolidation is going to work for you) is a realistic budget. I know that you are familiar with all of this from reading your blog!
Neil
October 2nd, 2008 at 12:43 pm
Debt consolidation involves tackling one major issue at a time. If you attempt to service all of your debt simultaneously with a limited amount of funds, you could stretch yourself too thin, leaving you without enough money to buy month-to-month essentials.