Why Debt Consolidation Doesn’t Work

Why Debt Consolidation Doesn’t Always Work

What is debt consolidation? It is when you add up all your personal debt including credit card debt, unpaid medical bills and outstanding loans. You can chose to pay them all off with a zero to lower interest credit card or a home equity loan. This will help you in two ways, less payments will be going out at a lower interest rate.

But is it really helping? The lower interest credit card will, after a limited time, increase the interest rate. If you use a home equity loan, that is a second mortgage on your home. The second mortgage will have to be taken care of before you can sell your home or must be included in the selling price. If you have to sell before the second mortgage is paid off, this lowers the profit you would have got without having the second mortgage. Plus if you cannot make the payments on the home equity loan, you may lose your home. Part of some home equity loans allow the creditor to sell your home to recoup money loaned to you if you default on the loan.

Before deciding to do a debt consolidation, try calling your creditors to work out a feasible payment plan. Advise them your situation is (hopefully) only temporary and you will need to lower your payments until you can get back on you feet financially. The Fair Debt Collection Act can help protect you from being harassed by your creditors.

Debt consolidation is known as a quick fix for a limited amount of time. But if you do not change you ways of spending by decreasing the number of credit cards you have and use and learning to wait until you can actually afford those luxury items, you will eventually find yourself back in the same predicament. Only it could possibly be worse, if you have not paid off the first consolidation loan. This could lead to having to file bankruptcy. Bankruptcy should only be done as a final resolution to your financial woes. It stays on your credit history for seven to ten years depending on whether you file under Chapter 13 or Chapter 7 of the bankruptcy code. Thus making buying a big ticket item such as a home or car almost impossible at a low interest rate. Because of the bankruptcy filing, you become a poor risk and may have trouble finding a creditor.

One other alternative would be to seek free credit counseling from a reputable service through the National Foundation of Consumer Counseling. They work with the borrower to set up a workable plan to repay creditors by teaching how to use a budget effectively. Second, they will try to negotiate an extended repayment plan if after setting up the budget there is a shortage of income to what has to be paid out. Because of this available alternative, debt consolidation is not always the best answer to resolving credit debt problems. (Winger, B.J. & Frasca, R.R. 2006)


Winger, B.J. & Frasca, R.R. (2006) Personal Finance (7th ed.) Upper Saddle River, NJ: Prentice Hall, p 163