Unfortunately, debt consolidation is not the ultimate answer to all of your issues with debt. There are only a few times when it is better to consolidate your debt rather than adopt other savings strategies to fix it. It can be a risky strategy depending on your situation as you’re dealing with a large amount of credit debt and consolidating it can have a large effect on your credit score.
When not to consolidate
Credit Score
In some cases consolidating debt may have a negative impact rather than a positive one, especially in regards to your credit score. “Older accounts have a more positive impact on credit scores because they reflect a proven track record of creditworthiness. When you consolidate your debts, the old accounts are closed and replaced by one new account.” [1] If you’re trying to consolidate a small amount of debt that will pay off easily, or if the debt exceeds half of your income and will take you longer than five years to pay off, then it will not be worth the effort to consolidate. It will remove the established accounts from your credit history and replace them with one new one, which will not reflect a trustworthy history.
Spending Habits
Spending habits can be large part of your need to consolidate debt. Before you decide to consolidate, make sure that you’re ready to stick to curbing your spending habits. The consolidation will give you more “room” on your credit cards and it can be tempting to abuse the newfound freedom. If you succumb to your old habits, it will turn the consolidation into only a delay for the need to seek debt relief.
When to consolidate
If you know that consolidation will help you responsibly make on-time payments and within a reasonable timeframe, then this could be the push you need to get a handle on your debt. Before you make any permanent decisions to start shifting around your finances you need to know the different options you have to consolidate your debts.
Credit card consolidation
One of the sources your debt may come from is credit card debt. If you have large amounts owed on several cards with high APR’s, credit card consolidation may be just the thing to get your payments under control. You will want to make sure you thoroughly review your options and choose a card with a lower APR than your old cards. Once you make this move, you’ll need to stay committed to making your payments on time and with a healthy amount towards the payments, you should have extra funds from the consolidation.
Consolidation loans
Another option on the board for consolidation is a consolidation loan. This mode of consolidation will allow you to take out a loan to pay off several of your current debts, turning it in to one loan payment each month. Ideally you would want the APR on the loan to be lower than the rates on any of your other loans or cards. Of course the rate will be based off your credit score, so if you have bad credit, consolidation may not be the right financial move for you.
Before you consider consolidation as a way to handle your debts make sure that the math adds up– if combining all your payments into one ends up costing you more in the end it is time to consider a different avenue. Utilize our Debt Consolidation Calculator to make sure this is right option for you.
Source:
[1] When is debt consolidation not a good idea, Money Management International
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