Why debt consolidation is not always the answer

If the only debts you have are mortgages on property, you can safely skip debt consolidation. However, if you also have credit cards, store cards, interest-free deals, personal lines of credit, car loans or personal loans, you need to read on.

Debt consolidation is often life changing and is simple to do, which is why so many people consolidate debt every day. Of course, we also know that all that glitters is not necessarily gold, so let’s take a look at what consolidation is, why you should or shouldn’t do it, and how to get it right if you decide to go ahead.

Quite simply, debt consolidation is the combining of several debts into a smaller number of facilities, preferably one. For people with property, this often means paying out higher interest personal credit with money borrowed under a lower interest mortgage loan. By consolidating your debts this way, merchants gleefully tell you that you can:

  • Make your life easier by eliminating several different payments at different times and replacing them with one easy payment
  • Lower your monthly payments
  • Save thousands in interest by switching from a ridiculously high interest rate to a much lower mortgage interest rate.

Now I know I’m a tad cynical, but the ‘single payment’ benefit is a bit of a red herring. It’s like the furniture salesman throwing in free fabric protection on your new lounge. You might take it as a part of the deal, but you wouldn’t walk into a shop to buy fabric protection and get the lounge thrown in. It’s a warm and fuzzy feel-good bonus designed to titillate your interest and get you ‘over the line’. With internet banking and direct salary debiting, most people don’t really get any advantage from the old ‘single payment’ sales pitch.

However, the other two benefits are a completely different story. They are real and from a financial health perspective, they can be life changing. The catch is that you can’t significantly lower your monthly payments AND still save thousands in interest. Although consolidation could be an important step in reclaiming control of your money, there are three vital facts you must understand before you leap into the dark abyss:

  1. Debt consolidation is the quick fix, yo-yo diet of finance – many people who do it often wind up in worse shape a year or two down the track.
  2. If you need to consolidate debt, you are already being beaten at the credit game. Your opponents are the banks and their expert friends who ‘helped’ you into debt so they can silently nip money from your pocket. However, you are not losing a credit ‘game’ so much as you are losing money, and the time it takes you to earn that money.
  3. Choosing debt consolidation to lower your payments means you are still being beaten by the banks and the brokers, just different banks and different brokers.

Remember, many people who consolidate their loans will fall back into old habits. Each time you consolidate debt to your mortgage you are surrendering equity in your property. It’s like trading a part of your house for that new couch, the latest TV, a pair of shoes or a night out on the town. So before you reach for your credit card, ask yourself, “is this really what I want to do?”.

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