Debt Consolidation – The Pros and Cons

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The following is a guest post. Enjoy! 

Debt Consolidation – The Pros and Cons

Getting on top of debt can be a full time challenge, especially if personal circumstances have changed since a loan or credit card was applied for.

No matter how the debt has come about, ignoring it can lead to serious consequences that are best avoided. Arguments in the family about money are one of the main reasons relationships fail, so making sure that there is a good debt management strategy is vital to a happy family life.

Understanding the Debt Consolidation Solution

Debt consolidation loans can be a good way of restructuring financial affairs so that they are more manageable in the medium term.

For those with a good credit history, applying for a new fixed term, fixed rate loan should be a straightforward way to raise new funds with which to pay off existing high rate borrowings. Those with less than perfect credit histories could benefit from a new loan even if the terms are no so advantageous as the good credit customers.
Debt consolidation loans work when there are large amounts of high rate debt outstanding. Typically, this means high balances on credit or store cards, where the monthly interest charged can be close to 20% annual percentage rate. These loans can also help where there are existing loans where the monthly payment is high due to its short term nature (for example, a two year car loan). To reduce the monthly net cash outflow, the new loan has to be over a long term and at the best possible interest rate. The total amount of interest paid over the life of the loan may be higher that the existing debt, but it has the advantage of reducing the monthly payment to an amount that can be afforded. This can then help free up cash for other important bills.

The Limitations of Debt Consolidation Loans

This approach can only work once or twice. What is also needed is a change of lifestyle so as not to increase the amount of debt once the debt consolidation loan is in place. Credit card usage needs to drop and additional borrowing put on hold, so attitudes to borrowing and how to live within a set budget are as important as clearing existing debt balances.

It may even be that a change of lifestyle can help get your finances back under control more quickly and easily than applying for a debt consolidation loan. If this is the case, then look for a zero interest credit card transfer deal and use the free period to pay down the balance. This will be far cheaper than any new loan can ever be.

It may be possible to combine these two approaches to make the best of both options available, where interest free borrowing can be achieved combined with a smaller debt consolidation loan.

If all of this sounds complex and frightening, then free advice and help is available from a number of debt counselling sources. Whilst inactivity is not a good idea, neither is indecent haste, so checking all options available and making sure that you have the best solution to match your personal circumstances is the best approach.

How about you all? Have you ever used debt consolidation loans? If your debt was spiraling out of control, what method would you use to combat the problem? Did you ever consider 0% interest credit card balance transfers? 


Share your experiences by commenting below!

Jacob’s Thoughts – Listed below are my random thoughts as I was reading this article.

  • Great article here! One thing I’ve always wondered is if there are any qualifications (such as income level) in order to obtain a debt consolidation loan? Does any one have any experience with this?
  • I think that it’s also important to point out that debt consolidation loans are not an “easy way out.” They should only be used if someone is having real trouble making the minimum payments on their credit cards each month, whilst still having enough money to live on. 
  • For most people, who merely have more debt than they’d like and want to get rid of it, debt consolidation most likely is not the solution. However, what is the solution is to 1) collect your debts, 2) finalize your Debt Free Action Plan, and 3) call your credit card company to get your interest rate reduced.

***Photo courtesy of http://www.flickr.com/photos/exurban/4857586543/sizes/m/in/photostream/

Comments

  1. Wow this is a great article that is actually easy to understand. I've read dozens of debt consolidation blogs lately (just got divorced) and yours is wonderful. I honestly think I'll work out my issues with the companies directly rather than getting such a high interest, short-term loan.

    • Thanks for reading Ryan! That's probably a good plan. Like I mentioned in my commentary above, debt consolidation loans should only be used as a “last resort” when other methods are working.
      My recent post Debt Consolidation – The Pros and Cons

  2. Buck Inspire says:

    Great advice. Don't have any experience in this area, but sounds like a solid plan for anyone battling debt problems.
    My recent post Auto Insurance Shopping

  3. PlanningFinancially says:

    One of the most important points you make here is that, once you choose a debt consolidation option, you have to change your lifestyle. A lot of people who find themselves in serious debt are repeat offenders. You have to learn your lesson and commit to smarter financial decisions for debt consolidation to have the desired effect. Also, it can be helpful to seek out professional assistance from an expert. Speaking with a financial professional might cost a little money, but you could end up with sound advice that could not only help you eliminate debt, but avoid it in the future.

    • Thanks for sharing that PlanningFinancially! In your opinion, what's the best way to go about changing habits?
      My recent post Carnival of Passive Investing 6 – May 2011 Edition With Author Rick Ferri Now Live!

      • PlanningFinancially says:

        Personally, I find that keeping a spending diary is the best way to gain control over your finances. Like a calorie diary when dieting, hold yourself accountable by noting every little detail. A grande cappuccino here, a car payment there – everything. At the end of the week, see how much of your spending was wasted on items that were wasted impulse buys. Answering to yourself can be great for self discipline!

  4. Hey Jacob,
    In response to your thoughts, it is usually not so much about the income level that a person has, but more so about how much income they have left over after their expenses. If they have too much debt, and other expenses, a lender would be reluctant to make the loan simply because they don't want to be the one that gets defaulted on if the borrower can't get things turned around. I usually recommend that my clients first trying lending club or prosper.com if they are looking for a consolidation loan. Right now, it is difficult to get that sort of loan from a traditional bank.
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