The Benefits and Drawbacks of Debt Consolidation

A lot people find that over time they have accumulated more debt than they can pay off. When that happens, there is a reinforcing downward spiral. The incapability to repay debts extends to additional interest charges and penalties, making it harder to settle the amount owed.

One common suggestion to get out of this vicious circle is to apply debt consolidation. For thousands, this has seemed like the way out, the way back to a healthy financial life. But there are pros and cons to debt consolidation, regardless of its form. Knowing it will help you decide if it is the salvation in your particular circumstances.

First, what is ‘debt consolidation’? At base, it’s a simple plan. Gather all your various sources of debt into one debt and give a single payment every month to a single debtor.

But for that to be helpful quite a few things have to take place at once. After all, whether you pay $150 + $50 + $25 to three debtors or $225 to another it’s the same quantity. With online bill payment you can avoid making three checks. You aren’t even saving on postage stamps!

In order for debt consolidation to actually help one or more of the following has to happen, depending on the particular debt consolidation plan you have chosen: (1) either the total monthly payment has to go down, or, (2) the net amount of interest has to decrease, or, (3) the actual total debt has to decrease as a result of the consolidation.

In the ideal case, which hardly ever happens, all three take place. The most common situation is that the monthly payment is lowered. This has several rewards to the debt ridden. When the payment is reduced, you have a much higher chance of pay it consistently.

That helps avoid piling of more debt (interest and late charges) onto current debt. You also have a much more relaxed frame of mind, knowing you can pay the monthly debt obligation without sacrificing basic needs.

The danger is that if the payment is too low, some of the psychological factors that led to extreme debt in the first place can rise again. Knowing you have lots to spare can cause you to loosen up too much too soon. Constant worry is not healthy; commitment and consistency are - if your objective is to become debt free.

Sadly, many plans lower the payment by extending the life of the loan long enough to cover paying off the total original amount owed. That leads to more interest paid over the long period. That’s reasonable to the lender, since you do owe the money. But some will settle for less if they have good reason to believe they will actually get repaid. Try to bargain for a lower settlement, then consistently make the agreed on payments each month.

Losing debt is similar to losing weight. Consistency, and a commitment to lower it, and keep it lowered, is the key to lasting success.