The Pros and Cons of Debt Consolidation

Are you struggling with credit card debt? You’re not alone. Credit card debt is increasing, and many Americans are looking for ways to get relief. Debt consolidation loans can make payments simpler, but they come with important downsides. In fact, 96% of people find that consolidation does not fully solve their debt problems. (Source: Forbes Advisor, Debt Consolidation Loan Statistics). Consider the following benefits and pitfalls of debt consolidation, when they might make sense, and a better alternative.

​The Problems With Debt Consolidation

Debt consolidation loans promise relief for people who are managing several credit card debts and loans by offering a single monthly payment, sometimes at a lower interest rate. If you have many debts, this can feel like a lifeline and reduce the stress of keeping track of different payments. However, before you decide, it’s important to know about some major drawbacks. Here are four key challenges to consider:

1. ​Debt consolidation services are businesses, not charities, and make money by charging fees. Expect closing costs of 3-5% of the loan amount, or more, depending on the loan type. These fees are often downplayed, which may lead to unexpected costs.
2. Debt consolidation is still a loan, and your credit score sets your rate. If past debt hurt your credit, your new rate may be no better than your existing ones. When you add closing costs, your debt could end up costing more overall.
3. Unlike credit card debt, which is usually unsecured, some consolidation loans may require you to put up something valuable, such as your home, car, or even a life insurance policy, to get a lower interest rate. This might seem helpful, but it’s normal to feel uneasy about risking something important. If you cannot pay back the loan, you could lose that asset to the lender.
4. Many people stay motivated by using the “debt snowball” method, which lets you pay off smaller debts first and build momentum as you move to bigger ones. When you consolidate, all your debts become one large loan, which can feel overwhelming and make it harder to see your progress. Having just one big payment might make it tougher to stay motivated to pay off your debt.
5. The last, and most important, challenge to consider before consolidating your debt is the fact that most people end up back in debt after they consolidate. Taking the action to consolidate your debt feels easy and even inconsequential, allowing you to consider debt as an option when times get tough. Remember, debt consolidation doesn’t solve the root of your debt problem; it simply moves the debt to a different owner.

When Debt Consolidation Might Make Sense

Despite the significant challenges debt consolidation poses, the move might still make sense in certain situations. But understanding when debt consolidation is the right strategy is crucial. Weigh the trade-offs carefully and consider these two scenarios when debt consolidation might help:

1. If multiple credit cards charge high interest rates (often 25% or more), debt consolidation could lower your overall rate and monthly payments. But consult a financial advisor or planner to determine if this actually saves you money. Avoid consolidating lower-interest debts, like student loans, as you might pay more in the long run.
2. If you’re on the verge of financial collapse, debt consolidation might offer you a lifeline to stabilize your situation. Combining debts into one manageable payment can provide some breathing room and help you avoid the serious consequences of bankruptcy.

A Better Path: Financial Counseling

A good alternative to debt consolidation is working with a financial counselor. For most people, debt is not just about numbers; it often comes from habits and behavior. No interest rate or payment plan can fix poor money habits. Take the first step and reach out to a trusted Christian Money Help counselor who can help you make a plan, keep you on track, and support you as you work toward becoming debt-free.