Debt consolidation has become exceedingly popular over the past few years, especially after the recession hit and we all began racking up more debt. But, what many individuals fail to realize about consolidation is the fact that it is a not a quick fix solution to debt, and that oftentimes it can cause an individual to rack up even more debt.
How Does Debt Consolidation Work?
Debt consolidation works by taking pieces of your debt, such as a credit card bill and a loan, and rolling the two together to give you a lower, single monthly payment. Sounds like a dream! Oftentimes this single monthly payment can even be arranged at lower interest rates than you pay for the initial accounts themselves. So, say you have a loan with a monthly payment of $324 at 10% interest and another with a monthly payment of $543 at 11% interest.
Each month, prior to consolidating your debt, you would be paying $867 for these two loans. However, should you consolidate your debt, you might be able to lower your monthly payment for these two loans to $622 per month at 9% interest.
For individuals who are searching for a way to manage their money or cut down on their monthly expenditures can certainly see the benefit of consolidating their debt into a payment that is much more manageable.
Why is it a Dangerous Answer to Debt?
But, before you jump at the opportunity to consolidate your debt, it is important to understand that while your monthly payments are smaller and your interest rates are lower, debt consolidation extends the period of which you will pay that lower monthly price. For instance, if you were paying both of the aforementioned loans traditionally at $867 per month, you might be free of these two debts in six years.
But, once your consolidated your debt it can actually extend the amount of time it will take to pay them off by an additional three years, and this means you pay more in the long-term, even with a lower interest rate. So yes, your monthly payments are lower, however the extended money and time of these debts may not be in your best interests.
Another danger that accompanies debt consolidation is the fact that those who consolidate don’t often learn the error of their ways for creating so many debts. They often consolidate and then return to their reckless spending habits which put them into debt in the first place. There is no lesson learned and good money management habits are not taught in this fashion.
While debt consolidation can be a great tool for those who are serious about paying off their debt and need a smaller monthly payment, it is not a fix all for the problem. It is important to approach this financial step with caution and the understanding that it can be dangerous if you do not understand the way it works. If someone tells you that you can pay one, lower monthly bill and at decreased interest rate, you always want to be skeptical and read the fine print.