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5 pros and cons of debt consolidation as a debt relief strategy

5 pros and cons of debt consolidation as a debt relief strategy

Keeping track of bill payments, balances, and loans can take time and effort. To simplify this, many people opt for debt consolidation – combining all debts under a new, singular loan or a balance transfer credit card. This is generally a good idea for those with multiple high-interest loans. However, debt consolidation has several pros and cons. This article explores the concept of debt consolidation to help one make informed decisions regarding debt relief.

How does debt consolidation work?
Debt consolidation merges all of one’s existing debt under one loan. This is a three-step process:

  • Take a new loan
  • Use the new loan to pay off old debt
  • Pay off the new loan

What are the advantages of debt consolidation?
Debt consolidation can be a fruitful tool for those with multiple high-interest loans. Some of the advantages may include:

  • Streamline finances: Combining multiple debts into one can help reduce the number of payments and interests one must worry about. This could benefit one’s credit, lowering the risk of making late or missing payments entirely.
  • Potentially lower interest rate: If one’s credit score has improved since applying for other loans, they could have a lower interest rate on a consolidated loan. This could decrease one’s interest payments. It is advisable to shop around to find a competitive loan for it. Debts can be high-interest (such, as on credit cards) or low-interest (student loans, for instance). When finalizing the payment details, consider these rates and focus on overall savings.
  • Faster payoff: If one’s debt consolidation loan accrues less interest than the individual loans, making extra payments to expedite the payoff is possible. This can help save money on interest.
  • Reduced monthly payments: With debt consolidation, total monthly payments tend to reduce as they are spread out over a new and extended loan term. This could help significantly reduce monthly payments.
  • Improved credit score: While applying for a new loan may cause a temporary dip in one’s credit score, responsible debt consolidation may help improve it over time. This happens in two ways. Firstly, paying off credit cards and other debt can reduce credit utilization. Secondly, making consistent, on-time payments to work towards being debt-free can also help improve credit scores.

What are the disadvantages of debt consolidation?
While it may sound like an appealing option, debt consolidation also has several risks and disadvantages associated with it. These may include:

  • Added costs: Some debt consolidation loans may have additional fees such as organization fees, balance transfer fees, closing fees, and annual fees. One must carefully consider these costs before finalizing a debt consolidation loan.
  • Could raise interest rates: Debt consolidation loans can be a wise financial decision for those who qualify for lower interest rates. However, if one’s credit score is too low, they may be stuck paying off higher interest than their current individual loans. Be sure to calculate these risks before signing up for any new loan.
  • Paying more in interest over time: Even if one’s monthly payments reduce with debt consolidation, one may pay more in interest over time. This is because the repayment timeline begins on day one and may extend for several years. This can cause debt to accrue over a long time. As a workaround, it may be beneficial to budget for monthly payments that exceed the minimum loan payment. This will expedite their loan payoff without tacking on additional interest.
  • Doesn’t solve underlying issues: While debt consolidation can simplify loan payments, it does not solve the underlying issues that led to loan accumulation. Debt consolidation loans may lead to more enormous debts. It is advisable to build healthy financial habits before turning to these relief tools.
  • May encourage increased spending: Paying off credit cards and other loans may give one the false impression that they have more money to spend. This can lead to a vicious cycle of debt, leading to increased spending once again. To sidestep this issue, make a budget and manage payments well to reduce additional debt.

When is debt consolidation an intelligent move?
Sometimes, debt consolidation can be a powerful tool to manage one’s finances. To find success with a debt consolidation strategy, one must have the following:

  • Monthly debt payments (including rent or mortgage) that do not exceed 50% of one’s gross monthly income.
  • One has a good credit score to qualify for a credit card with a 0% interest period or a low-interest debt consolidation loan.
  • One’s cash flow covers one’s debt payments consistently.
  • The debt consolidation loan can be paid off in five years.

Surmounting debt may also lead to delays in the payment of taxes. This can quickly add up, generating interests and penalties of its own. This tax debt can be negotiated with the IRS to reduce liabilities. If one does not qualify for negotiations, the IRS allows individuals to consolidate back taxes in installment agreements for multiple years of delinquency. Depending on one’s financial situation, one may also opt for other debt-relief tools, such as debt settlement, credit counseling, debt management plans, or bankruptcy. Each option has benefits and drawbacks that must be considered carefully to ensure financial well-being. Choosing the right debt relief option is based entirely on individual circumstances, goals, and preferences. Taking proactive steps to reduce debt can ensure financial success and stability. For help or guidance regarding debt management, it may be helpful to talk to a trained professional.

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