The Downside to Debt Consolidation Loans

Posted on September 24, 2007 by Eric
Filed Under Credit Cards, Debt

I would like one loan for everything please! When I started my first job after college, I didn’t own much. I had my car, some hand-me-down furniture, some clothes, a TV and VCR, a computer, some books, and a variety of other small things. I didn’t have much in the way of assets, and the furniture I had was really starting to show it’s age.

I managed to get a good job and it payed well. Considering I had so little when I moved, and I thought I was doing well, I decided to “move on up”. I upgraded my TV from a 13″ to a 27″. I bought new furniture, including new couches, coffee table, entertainment center, and end tables. I bought some movies, new books, and a smattering of other things. Before I knew it, I had $12,000 in credit card bills. By some people’s standards, that might not seem like a lot. For me at the time, it was huge. My father had always told me to avoid debt, and never carry a balance on your credit card. He’s never had to pay a finance charge on his credit card before. I hadn’t either up until this point.

I knew I had to find a way to pay the debt down. So I took out a debt consolidation loan against my car. Everything worked out fine, and I managed to get out of debt at that point fairly painlessly. I didn’t learn the lesson completely (I’ve had debt since this incident), but in my case the debt consolidation loan actually worked out pretty well, and saved me some money in the end.

Now, I’ve got a friend who has never handled his money well. He’s made some bad decisions in his life when it comes to finances. He’s actually a very, very smart guy, but he just doesn’t always think when it comes to spending money. I guess I’ve been there too, so I don’t judge him, but he did make a decision that confused me recently.

Things had been going well for him for a bit, and he just got a debt consolidation loan. This loan lowers his overall payment requirements each month, has a lower interest rate, and helps him get all his debt into one place. It looked like a pretty good plan to help him get out of debt.

But then, shortly after he had everything setup, he went out and made some purchases on his newly paid-off credit cards. After going through all the trouble to consolidate his loans he started filling up his credit cards again and created even more debt. He purchased some things that he wanted, but couldn’t afford until he had more room on his credit cards. The things he bought were far from necessities.

Now he has to worry about paying off both the loan and the new credit card balances. It seems that he’ll be in debt for a while longer. He understands what he’s done, and that it’s not the best financial move, but it doesn’t seem to change his behavior. Instead of working to pay down that loan, he just compounded it by adding even more debt.

Normally I wouldn’t advocate cutting up your credit cards. We use our credit cards extensively, but we ensure that each month we don’t carry a balance so we avoid paying finance charges. If you use your credit cards responsibly they can be a very convenient and useful tool. If you have rewards, you can even get some cash back or some other type of reward for using them. In this case, I think my friend is too tempted by available credit and might be better off just cutting up his cards.

If you get a debt consolidation loan, make sure you keep these things in mind :

Make sure that the deal you are getting is actually giving you a lower interest rate than what you are paying now. And make sure that there aren’t any unnecessary fees.
Setup a budget that allows you to always make the loan payment and stick to it. This will help ensure you aren’t living outside your means and that you are paying off the loan.
Stop using your credit cards until the loan is paid off. Maybe stop using them entirely if you don’t think you can handle the temptation.
Pay off the loan early if possible. I paid my loan off about 6 months early to get out of some of the interest. It’s definitely a good goal to have.

Debt consolidation loans can work for you, but only if you work within some basic guidelines and exercise your self-control when it comes to your credit cards. According to Bankrate.com, 70% of people who get debt consolidation loans have the same, or higher, debt loads 2 years after they get the loans. If you think a debt consolidation loan would work for you, do some research before you commit to anything. Get some help from a financial advisor if you can. Don’t wind up in the 70% that don’t reduce their debt at all.

Image Source: SqueakyMarmot

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