Is it a Good Idea to Consolidate Debt?

Debt consolidation offers potential advantages and disadvantages.

Debt consolidation offers potential advantages and disadvantages.

Carrying a lot of debt, especially on multiple credit cards, can make effective debt management difficult. One available method for getting a handle on your debt is consolidation, where you combine your debts into one obligation that usually offers a lower interest rate. The various debt consolidation options offer certain benefits, but they can also pose potential problems.

Borrowing Against Your Home

A common debt consolidation method is to borrow against the accumulated equity in your home in the form of a home equity loan or line of credit. You use the proceeds to pay off your high-interest debt. Home equity loans and lines of credit feature low interest rates, and as of 2012, some or all of the interest may be tax-deductible. A danger of this type of consolidation loan is that if you default on the payments, the lender could initiate foreclosure proceedings and take your house.

Balance Transfers

Debt consolidation can also take the form of a balance transfer, which is common in the credit card industry. A credit card issuer may send you an offer where you receive a low interest rate on a new card for a specified period of time if you agree to transfer the balances you carry on competitors' cards. While transfers can provide short-term debt relief, you'll need to read the offer carefully to determine the change in interest rate after the initial period ends. Some companies may also charge transfer fees.

Consumer Loans

Some consumer finance companies offer debt consolidation loans that allow you to pay off multiple debt obligations and make only one monthly payment. While these loans offer convenience, the fact that they are normally unsecured, meaning you are not required to back the loan with collateral, can mean your interest rate will still be relatively high. When the additional fees that many of these loans include are factored in, you might not be getting such a great deal.

Considerations

Before embarking on any type of debt consolidation plan, you should take the time to perform an honest self-assessment. A danger of many types of debt consolidation arrangements is that they may leave you free to incur more debt. If you've always had difficulty controlling your spending, which is probably why you saw the need for debt consolidation in the first place, the temptation to use the credit may be hard to resist. As a result, you might end up even deeper in debt. Learning how to manage your existing debt through methods such as credit counseling or budgeting might offer a more effective long-term solution.

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