When your debt has spiraled out of control and bills get to be overwhelming, there’s one final option you may start to consider: debt consolidation.
Debt consolidation is essentially a large loan that pays off your debts – meaning that instead of managing a dozen different bills, due dates, and interest rates, you’ll end up making one payment that will be distributed on your behalf through a debt consolidation service.
It’s an intriguing option for those who may feel overwhelmed, but it’s good to do your research before signing up, as debt consolidation may not always be the right choice. There are drawbacks to it that everyone should be aware of before deciding whether to move forward with it or not. Here are four of the biggest issues to be aware of:
1. Insanely High Interest Rates
The appeal of debt consolidation is that you basically turn a whole host of different debts and combine them into one simple monthly payment. Than means you’re trading several payments, different due dates, and a selection of interest rates for a single monthly payment that’s often less than your original payments.
A lower monthly payment isn’t the whole story, though. You’ll want to keep your new interest rate in mind because it may all equal out to you paying more, not less. Always ask for your interest rate before signing up for debt consolidation, and make sure you check if the interest rate is fixed. The average APR for a debt consolidation loan is 19 percent. Anything significantly higher than that is a bad deal. And keep in mind that your credit score does have an effect on the interest rate you qualify for.
2. Fees
Debt consolidation is a business, not a free service, so there will be fees. You’ll likely be charged a percentage of your total debt and there may also be a monthly consultation fee on top of that. Good debt consolidation companies offer reasonable fees, but some firms take the opportunity to soak their clients with especially high fees. These fees might manifest as monthly payments or upfront charges.
It make take some math on your part, but be sure you figure out if your debt consolidation will still be saving you money after all the fees are done and paid for.
3. Good vs Bad Debt
No debt is truly good, because no one enjoys owing money, but knowing the difference between good debt and bad debt is important. Debt with low interest rates, like auto loans, for example, is a good form of debt. Anything with a high interest rate is “bad” debt. Credit cards – one of the most commonly consolidated debts – is usually considered a high-interest “bad” debt.
Consolidating debt is not a zero sum game, meaning you can choose to leave some debts separate from your consolidation if it’s to your benefit. Again, you may have to crunch some numbers here, but be sure you are consolidating the debt with the highest interest rates so you can get the largest benefit from your consolidation. It’s completely acceptable to pay off low interest debt on your own, separate from the consolidation. If you are unsure of which debts would be wisest to consolidate, consider speaking with a credit counseling service.
4. Landing Yourself in Debt Again
Debt consolidation, even when you get the best deal possible, is not a magic cure for your financial problems. A substantial change in your spending habits is usually necessary to avoid falling back into debt, a trend which is upsettingly common.
As you make your way through your debt consolidation, it will be to you benefit to take the time to determine why you accrued so much debt to begin with. People usually run up debt for two reasons: uncontrollable circumstances such as emergencies or medical issues, or poor spending habits. If your debt is a result of poor financial choices, then it’s time to identify and fix them on your own.
Think, do you spend money when your stressed or sad? Do you have trouble saying no to people who ask you for loans? Even if you clear yourself of debt through a consolidation, you might still be at risk of running up huge debts again and end up right back where you started in debt.
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