While debt consolidation may seem difficult to understand at first glance, it is really quite a simple topic—the name says it all. Concisely put, debt consolidation is consolidating your debts. This means that you take all of your various debts and consolidate them into one large debt with one payment.

Why Do People Use Debt Consolidation?

Debt consolidation is typically sold as a service that “makes it easier to manage your debt”. Instead of making six different payments on six different debts to six different lenders, you instead can roll all of your debts into one larger debt. Thus, you only make one payment to one lender.

It is easy to see the organizational benefits to this debt repayment option; instead of trying to manage a variety of payments to different lenders, you only have to keep track of one payment and one lender. The prospect of this entices many individuals to attempt a debt consolidation plan.

Pitfalls to Debt Consolidation

While debt consolidation looks attractive to most individuals, there are many potential pitfalls for this plan. Here are some things to consider before beginning a debt consolidation plan.

1.      Fees- Of course, a debt consolidation company will not work for nothing. The firms will impose “administration” and/or “processing” fees. These fees only add to your existing debt, so examine any extra fees and costs that the company will impose. These are fees that you normally wouldn’t have to pay if you kept your loans unconsolidated, so be sure to factor that in when examining whether or not you should use debt consolidation.

2.      Interest Rate- When consolidating your debts, the debt consolidation firm will also charge you an interest rate just like your other creditors. However, while you will only have to worry about one interest rate instead of multiple ones, this rate may be higher than the effective rate that you pay on the unconsolidated loans. In short, you may be paying even more in interest than is necessary.

3.      Length of Payment Period- While debt consolidation firms often offer to lower the interest rate, they also may lengthen the payment period. This will keep you in debt longer than your original debts would have, and also may incur more in interest payments.

4.      Secured Loans- One potential pitfall to debt consolidation is taking your unsecured loans and turning them into one secured loan. By pledging assets (typically your house) to secure the loans, you are risking your home and other physical assets o your ability to repay the loan. However, your various credit card debts are unsecured, meaning that the creditors will have no claim to your personal assets in the case of bankruptcy.

The Australian Securities & Investments Commission also has some good tips on debt consolidation.

Do Debt Consolidation Companies Help You?

Even if a debt consolidation firm helps you to pay off your debts by condensing them into one single payment, there is still one looming defect of the system: you still haven’t changed the behavior. While hidden fees and extra interest payments are certainly costs you will have to endure with a debt consolidation plan, the most dangerous part of these plans is that they only treat the symptom—not the root of the problem.

Choosing a debt consolidation plan is only one way to try to eliminate your existing debt. Instead of trying to pay down your debt through debt consolidation, you can also choose to employ a proven, systematic way to pay off your debts. By paying off your debts, and learning how to live beneath your means, you can live debt free for the rest of your life.

Photo by Oberazzi

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1. Debt Consolidation Services: What You Need To Know
2. The Dark Side of Debt Consolidation
3. How NOT To Get Screwed on a Debt Consolidation Loan
4. Is Credit Card Debt Consolidation the Right Move?
5. Would a Debt Consolidation Loan Just Be Delaying the Inevitable?