Debt Consolidation – Pros and Cons

Many people find that over time they have accumulated more debt than they can repay. And many people know, debt can accumulate fairly quickly. When that happens, there is a reinforcing downward spiral. The inability to repay the debt leads to additional interest charges and penalties, making it still harder to repay the amount owed.

One common suggestion for breaking this vicious circle is to employ debt consolidation. For thousands, this has seemed like the way out, the way back to financial health. But there are pros and cons to debt consolidation, no matter what form it takes. Being aware of those will help you decide if it is the salvation in your particular circumstances.

First, what is 'debt consolidation'? In essence, is a process whereby all your unsecured debts are consolidated into one account, and you make only one payment (usually to a loan consolidation company) instead of several payments to different creditors. The loan consolidation company then pays all your creditors on your behalf.

But in order for debt consolidation to be useful one or more of the following has to occur: (1) either the total monthly payment has to decrease , or, (2) the net amount of interest has to decrease, or, (3) the actual total debt has to go down as a result of consolidation. Which, if any, of these take place depends on the specific debt consolidation plan you have planned.

In the ideal case, which rarely happens, all three take place. The most common scenario is that the monthly payment is lowered. This has several advantages to the debt ridden. When the payment is lowered, you have a much higher chance of being able to pay it consistently.

That helps prevent piling more debt (interest and late charges) onto existing debt. You also have a much more relaxed frame of mind, knowing you can meet the monthly debt obligation without sacrificing other needed items.

But there are a few things you MUST consider before you sign up in any debt consolidation plan. Fail to do this, and it could backfire on you, adding more problems to your life.

FIRST: There are two types of loan consolidation companies, for-profit and non-profit. Usually non-profit companies charge lower fees.

SECOND: If you are considering a loan consolidation company, ask them how much they charge every month. If they charge more than $35 or $45 per month, beware.

THIRD: This is probably one of the biggest issues. Some companies charge as much as $500 as a start up fee, which might be your first payment. And after you pay them $500 you may think all your accounts are being taken care for that month, which is not true if they apply all your payment towards the set up fee. Which means, ALL your accounts can be late the very first month! Look for a company that charges no more than $50 set up fee. Also, make sure that your first payment goes to pay your debts (minus the $35 monthly fee, or $45 depending on how much they charge) and not any other fees. Ideally, you should have only two fees, a $50 set up fee and a $35 monthly fee.

FOURTH: Make sure that your interest is lowered dramatically; otherwise it will not make financial sense for you. As an example, if your Citibank VISA charges you 29% interest, it should be lowered to 9,99% or something similar. Personal loans payments are usually 75% of the original payment.

FIFTH: For debt consolidation to work, you will have to learn how credit works. Just employing a debt consolidation agency will only treat the symptom, NOT the cause. Make sure the company you choose gives you REAL credit counseling. Unfortunately, some companies are only after your money. And they may provide a good service, but they have to educate you on how credit works. If they don't, you may go back to your old patterns once your debt is paid off, and you may find yourself deep in debt again shortly thereafter.

Now there is risk that if the payment is too low, some of the psychological factors that led to excessive debt in the first place can rise again. Thinking you have more money to spare can cause you to relax too much too soon. Continual worry is not healthy, commitment and concern are - if your goal is to become debt free.

Make sure your payments are calculated over a 5 year repayment term, and no longer than that. And that if you pay it off sooner, you will not be assessed any penalties.

Losing debt is like losing weight. Consistency, and a commitment to lower it, and keep it lowered, is the key to long-term success.

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