- 6 min read
- Finding the right debt consolidation solution for your individual situation requires weighing the pros and cons.
- Different options are available to you, depending on whether you have strong credit.
- Commit to a solution you are confident you can see through to completion.
Weighing the Pros and Cons of Debt Consolidation
Millions of Americans are struggling with debt. The average amount of credit card debt for people who carry a balance on their cards each month is over $9,000. Debt consolidation is a solution for people looking to get out of debt.
The stress from being in debt can feel overwhelming, making it hard to decide whether debt consolidation is right for you. Stress can make it hard to take action, even when you know you need to.
Here are some basic tips about the pros and cons of debt consolidation. Review them to eliminate your doubt and confusion and to help you sort through your options. Once you have decided if debt consolidation is right for you, you can move on to choosing the correct debt consolidation option to solve your debt problem and advance your financial goals.
What is Debt Consolidation?
Before we examine the pros and cons of debt consolidation it is important to understand what “debt consolidation” means. The term can be used to describe different programs and solutions for getting out of debt. The most popular form of debt consolidation is a debt consolidation loan. Debt consolidation can also be used to describe a cash-out refinance loan, a consumer credit counseling program and debt settlement.
Debt Consolidation Pros
Reduce your interest rates- A lower interest rate can save you money. Three debt consolidation options can reduce your interest rates: cash-out refinance, an unsecured debt consolidation loan, and a Consumer Credit Counseling program’s Debt Management Plan (DMP).
Cash-out Refinance- If you own a home with equity and your credit score is at least fair, a cash-out refinance will likely offer you the lowest interest rates.
Debt Consolidation Loan- If you are not lowering your interest rates by taking out a debt consolidation loan, then there is no reason to take one. Unlike a cash-out refinance, you have to pay off a debt consolidation loan in 2-5 years, so you won’t end up with a lower monthly payment.
Consumer Credit Counseling- The primary benefit of a DMP is that it obtains interest rate reductions from your creditors, saving you money and getting you out of debt faster.
Building Credit Score- A cash-out refi and a debt consolidation loan will help you build your credit score, if you make loan your payments on time. They both also pay off your current debts. In the case of paying off credit cards, you will improve your credit utilization, which improves your credit score.
Improve your monthly cash flow. A cash-out refi, a DMP, and debt settlement will reduce the amount you need to put towards your debts on a monthly basis. This increases the amount of money within your control, giving you flexibility to cover necessary expenses you may not have been able to afford.
Stop collection efforts- If you are falling behind on your accounts, then it is not likely you can qualify for a cash-out refinance or a debt consolidation loan. However, a DMP can put an end to those annoying phone calls from creditors.
Reduce stress- Carrying a growing debt can beat you down. The psychological benefit of making a decision and moving forward should not be underestimated. Once you put a debt consolidation solution in place, your positive step to improve your life empowers you, and gives you something concrete to build on.
Debt Consolidation Cons
Some debt consolidation options require strong credit- If you have poor credit, then you won’t qualify for a cash-out refinance. You need even stronger credit to qualify for debt consolidation loan. If you have less than an excellent credit score, you either won’t qualify or will be offered a higher interest rate.
If your credit score prevents you from getting a loan, look at a DMP or debt settlement.
Borrowing more than you need- Personal loan companies have a minimum loan amount. Even if it is not a question of required minimums, a loan officer may encourage you to borrow more than you need. Think carefully about what you need and don’t borrow more. It is easy to be tempted by money offered to you now that you don’t have to pay back until later, but your goal is to get out of debt, not increase it (short of a very good reason). It is very tempting to just freely spend that “windfall” and thus continue the poor spending habits that put you in this position.
Taking a longer time to become debt free- A cash-out refinance stretches your debt repayment to 15 or, more commonly, 30 years. The benefit of the cutting your monthly payment to service your debt may be important, but weigh it carefully, as extending the time to repay the loan will cost you more money in the long run.
Not all-inclusive- Debt consolidation may not cover all your debts. A cash-out refinance and a debt consolidation loan may limit the amount you borrow due to your debt-to-income ratio, the amount of equity you have, or your credit score. A DMP and debt settlement won’t accept secured debts. Any of these can be the right choice, even if not all debts are included, but you should have a plan for debts outside of your debt consolidation solution, so you can pay off all your obligations.
Fees- All forms of debt consolidation have some fees and costs. That doesn’t make any choice a bad one, necessarily. It does mean you should be aware of the costs that come with the solution, so you can make an informed choice.
Not solving your debt problem- To be successful, debt consolidation requires lifestyle changes, so you don’t repeat the same behavior that caused you to build up debt. Be committed to budgeting and controlling your expenses. Don’t take out a debt consolidation loan and then run up new credit card debt. If you do, you will have made your debt problem worse, instead of solving it.
Use the Debt Navigator
The BIlls.com Debt Navigator is a free tool that will give you a recommended debt consolidation option based on your answers to a series of short questions.
Make a Decision and Stick with It
Now that you understand the key factors to weigh, you can make an informed decision about the right debt consolidation option for your situation. Whichever debt consolidation solution you put in place, it is only a part, perhaps an essential part, of your overall financial well-being. Understand the impact of your debt consolidation solution in the short-term and long-term. Commit to a solution you are confident you can complete. It takes discipline to make serious changes. Sticking to a debt consolidation solution for a number of years establishes good habits that will benefit you throughout your life.
Struggling with debt?
If you are struggling with debt, you are not alone. According to the NY Federal Reserve total household debt as of Quarter Q4 2022 was $16.91 trillion. Student loan debt was $1.60 trillion and credit card debt was $0.99 trillion.
According to data gathered by Urban.org from a sample of credit reports, about 26% of people in the US have some kind of debt in collections. The median debt in collections is $1,739. Student loans and auto loans are common types of debt. Of people holding student debt, approximately 8% had student loans in collections. The national Auto/Retail debt delinquency rate was 4%.
The amount of debt and debt in collections vary by state. For example, in Texas, 37% have any kind of debt in collections and the median debt in collections is $1997. Medical debt is common and 19% have that in collections. The median medical debt in collections is $835.
While many households can comfortably pay off their debt, it is clear that many people are struggling with debt. Make sure that you analyze your situation and find the best debt payoff solutions to match your situation.