It can be difficult to keep track of payments and balances on outstanding debts. Consolidating these debts into a single loan may simplify your finances, but the strategy of debt consolidation most likely won’t fix your underlying financial challenges. For that reason, it’s important to understand the pros and cons of debt consolidation before committing to a new loan.
Understanding Debt Consolidation
Debt consolidation is the process of paying off multiple debts with a new loan, often at a lower interest rate. Debt consolidation works by merging all of your debt into this one new loan.
The Process of Debt Consolidation:
- Take out a new loan
- Use the new loan to pay off your old debts
- Pay off the new loan
Pros of Debt Consolidation
1. Streamlines Finances- Combining multiple outstanding debts into a single loan reduces the number of payments and interest rates you have to worry about.
2. Could Lower Interest Rate- If your credit score has improved since applying for other loans, you may be able to decrease your overall interest rate by consolidating debts—even if you have mostly low-interest loans.
3. May Reduce Monthly Payment- When consolidating debt, your overall monthly payment is likely to decrease because future payments are spread out over a new and, perhaps extended, loan term. Keep in mind that this means that you could pay more over the life of the loan, even with a lower interest rate.
Cons of Debt Consolidation
1. May Come With Added Costs- Taking out a debt consolidation loan may involve additional fees like origination fees, balance transfer fees, closing costs and annual fees.
2. Could Raise Your Interest Rate- If your credit score isn’t high enough to access the most competitive rates on loans, you may be stuck with a rate that’s higher than on your current debts.
3. You May Pay More In Interest Over Time- Even if your interest rate goes down when consolidating, you could still pay more in interest over the life of the new loan. When you consolidate debt, the repayment timeline starts from day one and may extend as long as seven years. Your overall monthly payment may be lower than you’re used to, but interest will accrue for a longer period of time.
4. You Risk Missing Payments- Missing payments on a debt consolidation loan can cause major damage to your credit score; it may also subject you to added fees.
5. Doesn’t Solve Underlying Financial Issues- Consolidating debt can simplify payments but it doesn’t address any underlying financial habits that led to those debts in the first place.
6. May Encourage Increased Spending- Paying off credit cards and other lines of credit with a debt consolidation loan may create the illusion of having more money than you actually have. It’s easy for borrowers to fall into the trap of paying off debts, only to find their balances have climbed once again.
An Alternative To Debt Consolidation
After becoming aware of the cons of debt consolidation, exploring alternative options may be in your best interest. The option of settling your debt for less than what you owe is something worth exploring. CuraDebt has been helping individuals and small businesses for over 22 years nationwide. As of May 2023 CuraDebt received a score of 5 out of 5 on CustomerLobby for a total of 1179 customer views. CuraDebt is an Accredited Member of the American Fair Credit Council. Contact us for a free consultation. 1-877-850-3328.