Is Debt Consolidation a Good Idea For You?

As unsecured personal indebtedness continues its rise to historic levels, many citizens of the UK are looking at consolidating their various debts in order to lower their monthly payments on the debt. For some, this might be a prudent exercise. For others, however, rolling numerous debts into one loan or placing them on a credit card could be yet another step toward financial disaster. The trick is determining which is the case in your individual circumstances.

When to consider consolidating your debts

To be blunt, the time to begin weighing your options is when the longest list of available options remains. Start by creating a complete list of what you owe, then calculating the potential outcome you might realise by consolidating all or part of those debts. You will need to be reasonably certain that you will be able to handle the new monthly debt service payment for the entire duration of the loan. If you are unsure about your income in the future, it is best not to make plans based upon a best-case or even current scenario.
You should begin at least researching available credit opportunities before you find yourself frantically trying to lower your monthly costs. The greater the difference between your monthly income and your monthly expenses, the better your chances of getting a loan with favourable terms, such as low interest rates and your ideal loan duration period. The eternal paradox is that the more you need credit, the harder and more expensive it will be to acquire. Wait until you are over your head on a monthly basis, and you could find yourself running into a brick wall of rejection.

Why consolidate?

– Reduce monthly debt service expense – If you’re like most people, your primary objective of consolidating your debts is to reduce the total pounds you pay each month to keep up with your total indebtedness. A single monthly payment for a debt consolidation loan can be significantly lower than the sum total of the smaller monthly payments.

– Pay off high-interest debts – Older loans that were made before interest rates plunged to their current levels are certainly viable candidates. Credit card debt is an excellent candidate, even if your monthly debt service payment ends up being a bit higher than the total of your minimum monthly payments. Remember, those minimum monthly payments rarely do much to reduce the principal amount you owe, whereas a consolidation loan from a bank, which typically charges significantly lower interest, could improve principal reduction by approximately 20% over the principal reduction on a credit card.

– Maintain a good credit record, even when the budget is getting tight – While paying off an account early can actually diminish your credit score in some cases, being late on or actually missing payments can be worse, no matter the reason. By making a single monthly payment that is smaller than the individual payments on your outstanding debts, it can be easier (or at least possible) to keep up with all your expenses when money is tight.

When should you not consolidate your debts?

– When doing so will lead to a repeat of unproductive spending habits – The single biggest drawback to rolling a number of smaller debts into a single one is evident when the existing debts have been incurred to meet basic ongoing needs or to indulge in unnecessary discretionary purchases. While the monthly outlay will be reduced initially, you might be tempted to continue to use the newly-paid off accounts, especially credit cards, to once again cover monthly expenses and/or further discretionary purchases. This spiraling increase in expenditures can rapidly get out of hand, leaving you in an even more precarious position than you had experienced before consolidating those debts.

– When the consolidated debt will outlast the benefit of the initial expenditure – It is human nature to lose incentive to pay for something from which you no longer receive benefit. Say, for instance, you bought an appliance on a credit card, and paid only the minimum payment for a couple of years. Then, in the process of consolidating your debts, you included the remaining balance due on the card on a five-year loan, only to have the appliance break after a few months.

You would still be paying for that appliance for several years, despite the fact that you no longer own it. Even if you dutifully continue making your payments, you could well be left with a bitter taste, knowing that you are still paying for something whose value to you has diminished or altogether disappeared.

– When you are merely shifting debt from one vehicle to another – Credit card companies have begun aggressively pushing the alleged benefit of paying off other debts, particularly other credit cards, by adding those balances to their card. Since credit card companies typically charge higher interest rates and fees than banks, you may find that you achieve no real benefit by paying off one card with another. Your monthly minimum payment might decrease somewhat, but you will still be paying little or nothing against your principle debt. That is akin to setting fire to the money, for all the benefit you get.

The one element that too many people overlook when considering a debt consolidation loan or payoff via cash advance on a credit card is that a change in spending attitudes and habits is essential if you hope to gain any benefit from the loan. The cardinal rule when consolidating your debts is to not borrow more than you need. Adopting behaviors that actually reduce your expenditures is infinitely more beneficial than merely juggling the payment for those expenses among different financial vehicles. By doing both, increasing the efficiency of your debt service, while at the same time reducing the source of those debts can set you on a path to financial security, in both the short and long term.

Paul graduated in 2001 with a degree in Finance. Since then he has gone on to work for several of the UK's most well-known financial institutions.

An avid blogger and a huge football fan, Paul is here to guide you through the ins and outs of personal finance and perhaps save you some money in the process!

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