When financial obligations become unmanageable, many people turn to debt consolidation in the hopes of taking control of their financial health and digging out of debt. While debt consolidation can be highly effective at helping consumers eradicate debt, there is also a high rate of failure.
Thinking of debt consolidation to tackle your financial burdens? Here are a few tips for what not to do, so that you can find success through debt consolidation – instead of messing it up.
What is debt consolidation?
Debt consolidation is a payment strategy that eliminates the need to make multiple debt payments each month and instead requires the consumer to make a single payment toward the total outstanding balance. Accomplished through consolidation loans, balance transfer credit cards, or a home equity loan, a debt consolidation plan generally consists of borrowing a large sum of money to pay off all outstanding debt, which eliminates the multiple accounts, interest rates, and payment due dates and leaves the consumer with one outstanding balance, one interest rate, and one monthly payment to keep track of.
Though debt consolidation does not reduce the total amount of debt for a consumer, it typically does reduce the amount of money paid by providing a lower interest rate, manageable monthly payments, and short-term repayment schedule to help the consumer dig out of debt efficiently and affordably.
Tip #1: Do not continue living without a budget.
Not sticking to a budget is a good way to mess up your consolidation plan. Establishing a budget creates a roadmap for navigating your finances, ensuring you allocate your money as efficiently as possible to cover your living expenses, build an emergency fund, contribute to your retirement accounts, and of course, make adequate debt payments to see progress in your debt consolidation plan. If you do not follow a budget, it is easy to get off-track and overspend in unnecessary categories which can mean less money is available to allocate toward debt payments.
Tip #2: Do not continue using your credit cards.
When you consolidate your debt, your credit cards become part of one consolidated balance with one interest rate. Continuing to use your credit cards is self-sabotage. Though you are making timely payments toward your consolidation plan, your balance will not decrease. Continued accrual of new debt thanks to your credit card use will drive up your total balance just as quickly as you are making payments, inhibiting your progress and keeping you from getting ahead.
Tip #3: Do not agree to a consolidation plan that you cannot afford.
Entering a debt consolidation plan does not reduce your outstanding balance – only making timely payments will do that. Collectively, you still owe the same amount of money, but you now make only one payment instead of several with only one interest rate that applies to the total balance rather than having varying rates that apply to chunks of your debt. Regardless of the kind of debt you have, it is always important to make timely payments whether toward individual accounts or through a consolidation plan.
Before taking out a consolidation loan, opening a new credit card for a balance transfer, or applying for a home equity loan, make sure you can afford the payments and that the interest rate is such that it will allow you to make progress and get ahead. Agreeing to payment terms that do not fit into your budget is an obvious way to mess up a consolidation plan. Rather than consolidation helping you to get ahead and take control of your finances, those payments you cannot afford will just drag you further behind in a game of musical money that you will never win.
Tip #4: Do not just consolidate some of your debt.
It is illogical to consolidate only a few of your credit cards, but not all of them. Not consolidating all your debt is a good way to get into an ineffective consolidation plan. The goal of consolidation is to eliminate the need to make multiple debt payments and keep up with varying interest rates across accounts. If you only consolidate some of your debt, then you will still be facing multiple payments with varying interest rates. Sure, the consolidation plan may be effective in helping you tackle the debt you chose to consolidate, but why not consolidate it all? A debt consolidation plan is not truly effective unless it helps you get out of debt. Therefore, consolidating some debt, but not all, is a way to mess up your consolidation plan before you even get started.
Tip #5: Do not fall for the long-term consolidation plan.
An important benefit to consolidation plans is the overall savings. Typically, consolidation loans reduce the overall amount of interest paid on your debt because the collective rate is lower than what you are paying toward each balance. However, if you agree to an extended-term consolidation plan that has you making payments on your debt far longer than you would if you paid down each account individually, you may end up paying much more overall thanks to that deceptively low interest rate. Not to mention, life happens, and an unforeseen job loss or medical crisis could make it impossible for you to make payments for as long as you planned, which could result in dragging you deeper into debt before you can complete your consolidation plan.
Ultimately, there are plenty of ways to mess up your debt consolidation plan – many of which include mistakes made before even getting started on the plan. Debt consolidation can work, but it is not right for everyone. If your total debt is equal to more than half of your income, other debt-relief options may be a better choice. Consult a financial advisor for guidance in determining if debt consolidation is right for you.
