The idea of debt consolidation is to pay off existing loans with one loan and thereby have only one loan to pay off. This seems like a good idea if the new loan results in using less money to pay off the debts; but it may result in using more money to pay off the total debt and people tend to get further in debt after consolidation by continuing to buy with credit.
There is always a fee to consolidate debt and that fee may be difficult to determine in advance. This fee is added to the total debt and paid off over time; and that can be a very large amount of money — the fee plus interest on the fee for the term of the consolidated loan.
In order to see if you are better off, you would need to do a lot of math and most people do not know how to do that math. Instead they merely look at their total current payments and compare them to the consolidated payment, ignoring the terms of the various loans and the total amount of money they would spend to pay off the individual loans compared to the consolidated loan.
When is a debt consolidation loan a smart idea?
There is no single answer, but some general rules do apply.
- The interest rate MUST be lower than the interest rate (or combined interest rates) of the debt being consolidated.
- The repayment term (length of repayment) must be equal to or less than the term of the existing obligations.
- Your life situation must be such that you can afford the consolidated payment and NOT incur new debt.
- Never turn unsecured debt into secured debt (unless the debt in question is back taxes, back child support or some other more intrusive debt).
I am sure there are people that can make a debt consolidation work; in my line of work, I only see the people where it didn’t work. The reason was they violated at least one (but usually all) of the above rules.