Can Debt Consolidation Leave Me In More Debt?
Anyone who has researched debt consolidation loans as a means of better managing their debt load has surely come across an article or two outlining the dangers of debt consolidation.
Many detractors of the debt reduction strategy claim that it can leave the borrower facing a greater degree of debt than when they started. Here we will look at several of the negative beliefs that surround debt consolidation and demonstrate why the majority of them are simply untrue and unfounded.
The Stigma With Personal Loans
Despite the increasingly common practice, there is quite a large stigma attached to the idea of taking out a personal loan to pay off one’s outstanding debt. To some, this may be the sign of an individual in financial distress; taking out one loan to pay off another. It may lead others to believe that the individual in question is unable to service their debt load and simply putting off the inevitable debt default.
This belief is not rational since the same people who subscribe to this idea also see nothing wrong with refinancing a mortgage. Both accomplish essentially the same thing - replacing one’s current interest rate with a lower one.
Some people also falsely believe that debt consolidation loans always come with a high interest rate or that the process leaves the borrower in an even greater amount of debt.
Common Myths Debunked
Below is a list of the most commonly cited myths in regards to debt consolidation loans. As we will see, not only are they false, but the reality is often quite the opposite.
High Interest Rates
As with any type of loan, the interest rate one receives on a debt consolidation loan depends on a variety of factors, the most important of which is the applicant's credit score. Borrowers with a low credit score will indeed receive a higher than average interest rate, but this fact is not exclusive to consolidation loans and is true for any type of debt.
When evaluating interest rates, it is important to consider the type of debt being consolidated. Most people who decide to consolidate their debt with a personal loan carry high-interest credit card debt, which may range from 18.99% - 24.99% APR. The point of a consolidation loan is to secure a lower interest rate than the debt the borrower carries, and not necessarily the lowest interest absolutely available.
Accrue More Debt
While it is true that some people find themselves in a greater degree of debt after consolidation, this is not indicative of the process itself. When an individual takes out a personal loan to consolidate their debt, they use the loan to pay off all outstanding balances. By doing so, their credit cards and lines of credit now carry no balances.
Those who are irresponsible may decide to start using these recently paid off accounts to make purchases, leaving them in more debt than they were in before. When this occurs, it has everything to do with the lack of responsibility of the borrower, and not something inherent to the process of debt consolidation.
Ruining Your Credit Score
One of the most commonly levied criticisms against debt consolidation is that it lowers the individual's credit score. Once again, this has everything to do with how the borrower manages their debt.
For example, say that a person who pays off their credit card balances with a consolidation loan begins to purchase items on Amazon with their newly freed up credit cards. This increased debt load will increase their credit utilization rate as well as increase their total debt load, resulting in a reduced credit score.
Those who undergo debt consolidation responsibly usually experience an increase in their credit score, since their debt total amount of available credit doubles, thus lowering their overall credit utilization rate.
Advantages Of Personal Loans
- Single Monthly Payment: Debt consolidation leaves the borrower with a single monthly payment, which is much easier to track. Those who have multiple payments due per month are much more likely to miss a payment by accident
- Lower Interest Rate: Borrowers with credit scores of 680 and above can secure interest rates far lower than those typically carried by credit cards and other high-interest financing methods
- Lower Overall Cost: Lower interest rates mean lower overall cost over the lifetime of the loan. By contrast, it can take over a decade to pay off credit cards when just the minimum payment is made
The Bottom Line
There are many criticisms and negative connotations associated with consolidated loans which, as we have seen, turn out to be unfounded and outright incorrect. The truth is, debt consolidation is one of the best debt management strategies available and helps hundreds of thousands of people escape from burdensome debt each year.