Pay Off Credit Card Debt with a Debt Consolidation Loan

If you’re struggling with loads of high-interest credit card debt, there’s a good chance that you’ve at least thought about taking out a debt consolidation loan.  And, I understand the appeal of a consolidation loan, especially if you’re juggling multiple credit cards with hefty balances.

But is a consolidation loan a good idea?  Is it something you should consider as you work toward your goal of being debt-free?

Well . . . maybe?

As someone who offers debt advice for a living, I understand that, when it comes to debt, everyone’s situation is slightly different.  And that’s why I’m hesitant to give a sweeping, across-the-board statement that debt consolidation loans are “good” or “bad” for everyone.  Legitimate consolidation loan programs aren’t as predatory and potentially hazardous as, say, payday loans (which are, by the way, bad for everyone – no exceptions!).  That said, though, I do have some pretty significant reservations about them.

On the surface, debt consolidation sounds like a great idea:  Essentially, you take all of your existing credit card debt and, as the name suggests, consolidate it into one single loan – usually a secured loan with a better interest rate than you’d get from a credit card.  So, instead of making multiple payments to several credit card companies, you make one payment every month until your combined debt is paid.

Of course, there’s a little more to it than that – and, debt consolidation doesn’t guarantee a future free of debt problems.  If you’re considering a consolidation loan as a path to debt relief, it’s important to know exactly what you’re getting into.  Here are a few things to think about – before you apply for a debt consolidation loan:

• In most cases, your house is on the line.  The most common type of debt consolidation loan uses your home equity as collateral.  This is a big deal because you’re basically exchanging unsecured debt for secured debt.  Let’s say that you have $40,000 in combined credit card debt.  Something happens – you lose your job or you get sick or have a major financial crisis that leaves you unable to make your payments.  In a worst-case scenario, you declare bankruptcy.  Your credit score takes a nosedive and you end up dealing with calls from debt collectors.  This is stressful, and it can have a long-term effect on your financial and emotional well-being.

Now, let’s say that you took out a consolidation loan and you put your house up as collateral for that $40,000 debt.  You’ve just tied your debt to your biggest asset: Your home.  And if you can’t make your payments, you risk losing your home.  When you move your debt from an unsecured loan (as in, a loan with no collateral) to a secured loan (a loan that’s backed by something tangible, like a home or a car), you suddenly have a lot more to lose.

• You might not qualify for a legitimate debt consolidation loan. One of the most appealing things about debt consolidation loans is that they typically come with much lower interest rates than you get from a credit card company.  But most banks and financial institutions that offer debt consolidation loans won’t give those lower interest rates to just anybody:  If your credit score reflects a history of late or missed payments, or if your ratio of available credit to credit used is very high, you may not be eligible.
• It will probably still take a long time to pay off your debt. It’s important to remember that, although they may offer lower interest rates than credit cards, debt consolidation loans are not a “quick fix” to a debt problem.  Most debt consolidation loans are fixed rate/fixed time loans (just like a car loan or home mortgage).  You’ll make one fixed monthly payment, and you’ll have your debt paid off in whatever time is allotted, whether that’s 10 years or 15 years.  In most cases, that still may be faster than paying the minimum credit card payment – but it won’t get you out of debt overnight.
• Debt consolidation can’t fix an underlying spending problem.  This is one of my biggest concerns about debt consolidation loans.  While they can provide some short-term relief in the form of lower interest rates and more manageable payment options, they can’t do anything about the behaviors and habits that create debt problems in the first place.  In my experience, what tends to happen is that someone will obtain a consolidation loan, bring their existing credit card balances down to zero — and then turn around and immediately begin to rack up debt on their now zero balance credit cards, leaving them much worse off than they were before consolidating their debt.

So, you can probably see why, as a debt counseling professional, I’m somewhat hesitant to recommend debt consolidation loans to everyone struggling with high-interest credit card debt.  In some situations — if you’re absolutely sure that you can pay well above the minimum payments, and if you’re committed to changing the habits that got you into debt in the first place – a debt consolidation loan can provide a helpful stepping stone to debt-free living.

But in general, I’d recommend that you proceed with caution and check out some other options and debt repayment strategies before you go the debt consolidation route.  Want to discuss your debt?  Need some good advice and some help coming up with debt repayment strategies?  You can always contact the Debt Guru team today for a free debt consultation