A lot of times, debt consolidation, one of the solutions to issues of multiple debts is confused with other debt solutions like debt management and debt settlement. Notwithstanding, it functions in a way that is different from the other available debt solutions.
What it simply does is it puts on all your debts into one. This involves making a transfer of every single credit card debt in your name into one card, which more often than not comes with a low-interest rate. It could also be done by taking some amount from your retirement funds, taking a home equity line of credit, or taking a home equity loan.
Just like every other phenomenon, debt consolidation has its good and bad sides. Contained in this article are some of the advantages, as well as the disadvantages of debt consolidation.
That being said, let’s go through the advantages and disadvantages of debt consolidation.
Advantages of Debt Consolidation
- It is Good for your credit Score: Having to make several payments in a month is not a very easy thing. Sometimes, it can be easy to default on these payments.
Defaulting on a payment is bad for your credit score and is not what anyone wants. With consolidated debts, you can reduce the amount you pay monthly and thereby have an improved credit score.
- Single Payment: Debt consolidation does not bring about the cancellation of debt. It, however, does something of great importance. It brings about a form of focus which can help debtors settle their debts easily.
This is possible because debt consolidation involves consolidating all debts that a person owns into one major debt. Now, these different debts have different deadlines and should be paid at different times of the month. This might not have any effect on one’s ability to pay.
However, it might not be so easy to remember the exact time of the month every single debt is due. Well, when all debts are consolidated into one, all a debtor needs to do is pay a single monthly payment and the debt consolidation firm will handle the rest.
- A Reduction in Stress: More often than not, being in debt leads to an enormous level of stress. This stress can increase tremendously if one has to settle multiple debts all at once.
Well, if you are in debt and want to reduce your stress level even before paying off your debt, you can do so by consolidating your debt into one. Doing this will not only decrease your stress level; it will also help you focus on the things you should do to free yourself from debt.
Disadvantages of Debt Consolidation
- Credit Card Balance Transfer: Getting the debt you have on a credit card that has high-interest rate transferred to a credit card that has a low introductory rate might do some good in helping you with your debt, there are, however, some downsides to this.
If you transfer your debts from a credit card with a high-interest rate to one with a low introductory rate, you might enjoy low rates for a while. However, when the introductory rates are over, you might end up paying at a rate which is more than that paid on the former card. Making purchases with the new card will come at an increased interest rate.
Also, if you decide to pay just the minimum amount that can be paid on your credit card for a month, you might end up being in debt for much longer than you envisaged. That’s not all, compressing all your debts into a single credit card can sometimes have a bad effect on your credit score.
- A Relative Increase in Debt: Debt consolidation firms do not offer their services free of charge. Their services are paid for. These fees are usually not cheap. Also, the more money you owe, the higher the amount you have to pay in fees.
When seeking the services of a debt consolidation firm, apart from the obvious fees which you will have to pay to get their services, there are hidden fees sometimes.
Although this can be said to be very unfavorable to debtors, it is not all. Sometimes, there are clauses in the contract binding debtors and debt consolidation firms. These clauses enable debt consolidation firms to take their fees from whatever amount you give to them before they eventually begin remitting payments to your creditors.
The implication of this is your creditors might not get any money from your end for an extended period. The duration of the period that creditors might have to stay without getting any payments from you is dependent on how massive your debt consolidation fee is and how much you pay to the debt consolidation firm every month.
Now, this is a bad place to be in. It is even worse if garnishment from consumer debt are allowed by the laws of the state you are resident in.
- You Have no Control Over Payment: As soon as you begin working with a debt consolidation firm, you lose control over how payments should be prioritized. It is up to the debt consolidation firm you are working with to decide on how they want payments to go.
If the firm decides to send full payments to all your creditors every month or if they decide to send partial payments, there is not much you can do. You do not have a say. Your role is to make your monthly payments to the debt consolidation firm, and they will handle how the payments go.
- Your Job Might be Affected: A lot of debtors that are looking to work with debt consolidation firms are not aware that sometimes their jobs can be affected. Well, the truth remains if everything does not go as planned, your job can be affected.
In the process of trying to pay up your debt, sometimes, your creditors can get garnishments against you. When this happens, the garnishment is submitted to your employer. If you get lots of garnishments, it can make you demoted or even lose your job.
Apart from leading to a demotion or making you get fired from work, getting multiple garnishments can stand in the way of your promotion at work even if you are one of the best at what you do. This is so because it is very easy for your boss to assume you will not be able to manage the affairs of the company effectively if you can not handle your affairs very well.
- Debt Consolidation does not Solve the Problem: Taking advantage of debt consolidation loans might seem like it makes things a lot better. Well, it still is not the solution to your financial challenges. When you make use of debt consolidation in paying off your debts, it might reduce the amount that you have to pay monthly.
While it might seem as though you have some form of financial relief, paying a reduced amount every month will only end up making you spend more time in actually paying off your debt. Now, if you have no real financial goals, you might not have any problem with paying off your debt over a prolonged period.
However, having to pay your debt over a prolonged period means you will have to pay the interests on the loan over a longer period, thereby, spending more than you planned to spend initially.
- You Might have to Part with Some of your Retirement Money: To consolidate your debt, you have the alternative of borrowing from 401k. That, however, is not a good alternative. Borrowing from 401k means borrowing your money. Well, even if you are borrowing your own money, you will have to refund it in five years.
Failure to do so will attract penalties, as well as taxes from the Internal Revenue Service. Also, you will have to pay a full amount of the loan if you change or lose your job. Now, the aim of 401k is to have some money saved up for your retirement, borrowing this money means you will be eating into funds you should spend when you retire.
- Home Equity: Taking a home equity loan might be able to make you pay less on interests than you are currently paying on your debts. It, however, is a very risky way to go about your debts because putting your home on the line might make you homeless if you do not live up to expectation.
Sometimes missing your payment is as good as losing your home when you take a debt consolidation loan. It is possible to erase your credit card debt if you are about going bankrupt. Unlike credit card debt, you cannot erase home equity loans. This implies that taking a home equity loan might break you financially if you miss your payments.
You may also be interested in Debt Consolidation Pros and Cons: The Benefits and Alternatives