Debt consolidation is a dangerous game, but one commonly played. The concept is simple enough – combine a bunch of your small bills into one big loan, usually lowering your overall required minimum payment compared to all the smaller ones combined. You can sometimes get a lower interest rate and even more favorable terms (longer to pay or whatever). Sounds good, right? Well…wait a second. There are a few things about these types of loans I really don’t like:
- They are often in the form of a home equity loan. So…let’s say you roll a bunch of small credit cards (unsecured loans) into a home equity loan (a secured loan). What you’ve in effect done is gone from having an unsecured loan, where there was very little a creditor could do to you if you didn’t pay, to promising you’ll give up your house if you don’t pay. OUCH.
- They usually only treat a symptom. If a consolidation loan works as advertised, it will lower your overall monthly payments by rolling a lot of those small ones together. That’s all well and good, but it usually means you don’t generate the required discipline to stop overspending (the real problem). Most of the time, you end up deeper in debt because you got a little breathing room back, then you end up having to do another consolidation loan or something similar to keep up when it gets tight the next time. It can be a bad cycle. OUCH.
- What happens if you can’t make that one bigger payment? It is usually much harder to catch up if you’re behind on one big payment than if you’re behind on five or ten little ones. OUCH.
As you can tell, the math of a consolidation loan makes sense. But as you can also tell, personal finance has very little to do with math. It is about behavior. Change your behavior and your finances will almost always fall in line.