If you've run up debt that's getting out of hand, consolidation can be a powerful and lasting solution. However, if it's done badly, it can make a dangerous situation even worse. How can you make sure debt consolidation works for you?
What Exactly is Debt Consolidation?
The basic idea behind debt consolidation is to take out a new loan large enough to cover your existing debts, and then use it to pay them all off. Your monthly repayments on this new loan should be less than the combined repayments on your current debts, taking some of the financial pressure off and helping you make a new start.
Is Consolidation Necessary?
Before applying for a consolidation loan, you need to decide if it's the right choice for you. Instead, could you spread your debts around your existing accounts to save some money? For example, maybe you could use a low-interest bank overdraft to reduce the balance on your most expensive credit cards.
Or, maybe one credit card has a long-term, low-interest balance transfer facility which you could use to clear the card you normally use for spending. This would temporarily remove those repayments from your budget to reduce your outgoings.
However, for most people who are considering debt consolidation, their problems have gone beyond the stage where shuffling debts around can provide some breathing space.
Which Consolidation Strategy?
So, if you've decided that a consolidation loan is the way forward, you have two choices on how to make it work. You could find a low interest loan with manageable repayments, or you could take one at a higher rate but with payments spread over a longer period.
A loan with a higher interest rate but a longer repayment term is easier to get, so if your credit rating is poor, this is probably your only option.
Both of these methods will only work for you if they provide a lower monthly payment. If consolidation is just a last-gasp effort to stop threatening letters from debt collectors, but it doesn't lower your payments, then you're only putting off the inevitable. In this case, you're probably better looking at debt counseling, debt management, or even bankruptcy.
Secured or Unsecured Loan?
If you're a homeowner, securing a consolidation loan on your home will make it easier to be approved, and you'll normally pay a lower rate. However, think very carefully about this.
If your current debt problems aren't directly threatening your home, do you really want to bring your property into the mix? Defaulting on a secured loan will lead to foreclosure in the end, whereas defaulting on credit cards will just trash your credit rating.
After Your Loan
Hopefully, you'll find a loan where the figures work out and the financial pressure will be off. But that's not the end of the successful consolidation story.
To ensure you don't fall back into the same debt trap, close down most of your old accounts once they've been cleared. Leave open only the credit lines you need for everyday life. For example, you'll need one credit card for online shopping and so on, but close the rest to remove the temptation to go on a spending spree.
If you don't take this final step, you risk running up new debts while also making repayments on your new consolidation loan. This is a recipe for financial disaster.
Consolidation is a big decision, and not necessarily as easy and painless as the online ads pretend. If you rush it, you could make your situation much worse. But if you plan carefully and make sure the sums add up, it'll relieve your financial pressure and let you make a fresh start.