Debt Consolidation May Not Solve Your Problems

By Debbie Dragon   

What could be wrong with consolidating multiple credit accounts with varying interest rates into a single monthly payment? If you're struggling to find the $900 a month you need in monthly minimum payments for your unsecured debt, doesn't the thought of having a single payment of $500 or so sound like the answer to your prayers? Maybe, but debt consolidation may not rescue you from your financial situation. Here's why:

You may not qualify for a debt consolidation loan

Most debt consolidation loans are secured by your home mortgage. If you're not a homeowner, you can try to obtain a personal loan large enough to pay off your debts, but chances are you won't be able to. By the time someone decides they need a debt consolidation loan to help pay off debt and get a more manageable monthly payment, their credit score has often already taken a hit from late payments and high utilization of available credit. Those who start looking for a debt consolidation loan are often already in over their heads. Unfortunately, people in this situation will find qualifying for additional credit difficult because lenders view them as high-risk.

If you're a homeowner, the depressed housing market may still make it difficult for you to obtain a secured loan using your home as collateral. Many people are discovering they don't have as much equity in their homes as they used to; in some cases, they actually have negative equity.

Applying for a debt consolidation loan can also lower your credit score, so it's in your best interest to determine how likely it is that you'll qualify for a debt consolidation loan before signing the application. Doing so can prevent further damage to your credit.

Debt consolidation loans can cost more than the original debt

The economic downturn has spurred a number of debt consolidation companies to offer consolidation loans to people with poor credit. Such companies may be able to consolidate your debts so that you'll pay a lower monthly payment, but be aware that a lower monthly payment doesn't mean you're paying the same or less to pay off your debts. The debt consolidation loan may stretch out your repayments over a longer period of time in order to make lower monthly payments possible — but the longer it takes to pay back the debt, the more you'll pay in interest charges.

Depending on your circumstances and sense of urgency, paying more for the debt over a longer time period may at least make it possible to pay your bills on time with more affordable monthly payments. Still, this is a decision that should be carefully weighed to avoid paying more than you absolutely have to in debt repayments.

Credit addiction can linger

If you are approved for a debt consolidation loan with reasonable repayment terms, you may think you're home-free. But a debt consolidation loan can't rescue you from your financial situation if you're addicted to credit.

Many people actually end up in worse financial straits after consolidating their debts. Once their monthly repayments become manageable again, many people will start using their credit cards again. As their credit card balances increase, the borrower not only has to make payments on the debt consolidation loan each month, but on the credit card as well. Their total debt has grown ⎯ sometimes twice as large.

A debt consolidation loan can only rescue you from a financial crisis if you're approved for a loan with reasonable repayment terms — and if you're willing to permanently change the way you spend money and use credit.