Is it Smart to Consolidate Debt?

Legal Expert, Paralegal
Dena Standley, BA

Dena Standley is a seasoned paralegal with more than 20 years of experience in legal research and writing, having received a certification as a Legal Assistant/Paralegal from Southern Technical College.

Edited by Hannah Locklear

Editor at SoloSuit
Hannah Locklear, BA

Hannah Locklear is SoloSuit’s Marketing and Impact Manager. With an educational background in Linguistics, Spanish, and International Development from Brigham Young University, Hannah has also worked as a legal support specialist for several years.

Summary: Debt consolidation is loan financing that turns several debts into one loan. If you qualify for low-interest credit, you may save some money. You may also prefer dealing with a single account instead of coordinating several monthly repayments. Below is a guide to debt consolidation and its advantages and disadvantages, from SoloSuit.

“Need extra funds fast?”

“Pay all your loans today with a fixed interest rate!”

“Get 0% APR on your new loan.”

These are just some of the ads that make debt consolidation seem appealing.

You may be attracted to the idea of borrowing money to pay current loans, especially if you struggle to keep up with repayments. Some consumers use the opportunity to increase their spending. But as exciting as it sounds, debt consolidation can cause some serious financial issues.

Whether it is wise to consolidate debt or not depends on your needs. Before incurring additional liabilities, you should determine if the new loan will solve your underlying issues.

This article will discuss the pros, cons, and other variables of debt consolidation so you can decide if it is right for you.

When is it smart to consolidate debt?

You may want to consolidate multiple debts into one if:

You want to reduce the interest rates.
You are looking for a way to manage your finances better.
You want to reduce monthly payments.
You hope to speed up the repayment process.

Let’s take a closer look at each of these points below.

You want to reduce the interest rates

Suppose you have three credit cards and one car loan, all with high-interest rates. If you use a balance transfer card with 0% APR, you may save on interest.

There is one catch, though: You need to be able to access low-interest credit. This part is usually tricky because most consumers looking to consolidate debt need to catch up on several accounts. With a shaky credit score, getting your desired competitive interests becomes harder.

But if your credit score has improved, getting low-interest credit can significantly save you money.

Consider the example below.

Example: Susan has four credit cards with a combined debt of $1,800. The first card charges 11% interest, the second 13%, the third 12%, and the fourth 13%. Suppose Susan applies and qualifies for a balance transfer card with a 0% APR for the first 18 months and pays off the new loan within one year. She will pay back the loan with no interest. Susan will have saved money and gotten out of debt.

You are looking for a way to manage your finances better

Keeping up with several monthly payments and different interest rates takes a lot of work. Debt consolidation can help you streamline your finances, leaving you with just one monthly payment and interest rate.

You want to reduce monthly payments

The new loan you take to pay off current ones usually spreads over a longer repayment term, allowing you to pay less each month. Reduced payments can help free up some funds you may need to cover recurring expenses.

You hope to speed up the repayment process

As mentioned above, you may save some money from lower monthly payments. Using this extra cash to pay more than the minimum monthly amount can expedite paying off the new loan.

Next, let’s explore the reasons why you may want to stay away from consolidating debt.

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What are the risks of debt consolidation?

Despite the colorful adverts, debt consolidation still comes with risks. Consolidating your debt may be wrong for you if:

It can lead to unnecessary spending.
Your new loan comes with additional costs.
You have hidden financial issues.
You cannot afford the new monthly payments.
You risk losing your collateral.

It can lead to unnecessary spending

Credit cards are a common culprit. Unfortunately, relief from paying off current debts can lead consumers to run up their balances again. If you fall into this trap, your financial situation may become worse.

Your new loan comes with additional costs

Applying for a new loan can come with balance transfer fees, origination fees, closing, and annual fees. These costs can add up, making the new loan technically “unaffordable.”

Find out the actual cost of the new account before accepting an offer. Also, try borrowing from a bank or credit union. These creditors may not charge the above fees.

You have hidden financial issues

There are reasons why you ended up with so many debts in the first place. You need to address those issues first. A consolidated debt will not solve overspending, dependence on borrowing, or missed payments.

If you notice a problem managing your finances, you should work on that first. Otherwise, loan consolidation may drive you into more debt and even bankruptcy.

You cannot afford the new monthly payments

It would be unwise to pay off the original debts only to remain in debt beyond your means.

Before taking out a new loan, examine your income and expenses. If you don't have enough money to cater to daily needs and the new loan, it is best not to consolidate. Remember that missing payments on a consolidation loan can ruin your credit further.

You risk losing your collateral

Consolidating debt into a secured loan puts you at risk of losing your property. Whether it is your house, car, or 401(K) loan, falling behind in payment can mean the creditor has a right to your property.

On the flip side, unsecured loans are typically expensive. Because there is no guarantee, the lender charges you for the high risk that you may default.

Here is SoloSuit's guide to different types of debts.

Debt consolidation does not erase original debts

When you enroll in a debt consolidation program, you still owe the money from your original debts. The only difference is that you have transferred them from one creditor to another.

The new creditor may sound lenient. But that may be a marketing strategy. Only consolidate if you know that the new loan will put you in a better position to pay off your debts.

Read more: Risks of debt consolidation.

Should I consolidate my debts?

Taking out one large debt to pay off several small debts has advantages and disadvantages. One advantage is that you won't need to worry about balancing payments and interests on multiple accounts. Instead, you can streamline your finances with just one monthly payment.

But debt consolidation is only suitable for some. So due diligence and addressing underlying financial issues are necessary to determine if a debt consolidation loan will work in your situation. Additionally, consumers with bad credit may not qualify for debt consolidation.

Ultimately, it is wise to consolidate debt if you qualify for low-interest loans, want lower monthly payments, or prefer dealing with one creditor instead of several.

Debt consolidation can affect your credit score

Beware: debt consolidation will most likely lead to a drop in your credit score, but this is only temporary. This is because a debt consolidation loan looks like a new account added to your credit report, which usually brings a credit score down.

That being said, if you stay on top of your debt consolidation payments and successfully pay off all the debts, your credit score will end up increasing.

So, debt consolidation can have both a negative and a positive impact on your credit score. The negative effects will be seen at the beginning of the debt consolidation process, whereas your credit score will ultimately increase if you stick to the consolidation goals and make your payments on time.

You can use SoloSuit to fight debt collectors. If a debt collection agency keeps calling you, takes you to court, or reports wrongful information to your credit report, our products can protect you. And you do not need to hire a lawyer.

Check out this video to learn more:

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You can use SoloSuit to respond to a debt lawsuit, to send letters to collectors, and even to settle a debt. SoloSuit's Answer service is a step-by-step web-app that asks you all the necessary questions to complete your Answer. Upon completion, we'll have an attorney review your document and we'll file it for you.

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No matter where you find yourself in the debt collection process, Solo is here to help you resolve your debt.

>>Read the FastCompany article: Debt Lawsuits Are Complicated: This Website Makes Them Simpler To Navigate

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