Debt sucks!
If you currently have or have ever been deep in debt you know how crushing it can be.
One common way people attempt to deal with large personal debt is through a debt refinancing tool known as debt consolidation. Debt consolidation combines multiple debts into one single payments. this is accomplished by taking our one large loan to pay off multiple smaller loans.
What is debt consolidation?
- Debt Consolidation is simply a loan used to pay off other loans. It is in essence refinancing.
- Debt Consolidation does not guarantee, but typically offers lower interest rates than the ones currently being paid by the borrower, hence the attraction to debt consolidation.
- Just to re-reiterate, lower interest rates are NOT guaranteed.
- Debt Consolidation extends the length of your loan by offering lower monthly payments over a longer term thus keeping you in debt longer. In this way, it is similar to a forbearance.
How is debt consolidation different from debt forgiveness?
Debt Consolidation is NOT debt forgiveness. You are still responsible to pay back the debt you have accumulated plus interest.
Debt forgiveness is when you negotiate with a creditor to forgive part of your debt due to your inability to pay it back. This almost always comes with fine print and strings attached and there are many many pitfalls. Since this is an article on debt consolidation, not debt forgiveness, I will direct you to this article from nerdwallet if you want to learn more about debt forgiveness.
Is debt consolidation the same as a forbearance or payment deferral?
Debt consolidation is not the same as a forbearance or payment deferral although the principle behind them are the same. With debt consolidation, you are combining multiple sources of debt into one. Typically this will extend the total amount of time it will take to pay back the loan.
With a forbearance or payment deferral, current payments or overdue payments are pushed to the end of the load and the balance as brought to current. For example, if you currently pay $150 a month on a loan that is 4 months behind, you currently owe $600 (plus any fees). With a forbearance, the $600 is deferred until the end of the loan and your current balance due is reset to zero.
Of coarse you will still owe any late fees and interest on the corrent late payments which they will gladly add to the total loan balance due. And now the loan has been extended for 4 more months which means 4 more months of interest payments you are obligated to make.
When is debt consolidation a good idea?
I can think of only one way debt consolidation can be a good idea and I myself have done this. What I did was secure a limited time zero percent credit card, pay off all my other debts with it, and then pay off the zero percent credit card before the interest started to accumulate,.
A word of caution thought as this can be extremely dangerous. If you fail to pay of the debt entirely then you will be stuck with very high interest payments. I do not recommend this to anyone.
The only reason I did it was because I was fairly certain I would be able to pay the balance 100% well in advance of the interest beginning to accumulate.
Why debt consolidation is a bad idea
Debt consolidation is a tool for the desperate. You can call it a loan refinance, a forbearance, or payment deferment but they are all the same and all of them will hurt you in the long run.
If you were either dumb enough or unfortunate enough to get yourself deep in to debt then you need to bite the bullet, own it and work towards getting out. The desperate tools offered to you by the banks (Forbearance, refinance, consolidation, etc) will only serve to keep you indebted to them longer.
Take this example…
On Loan #1 you owe $12,000 at 11% interest. You are making monthly payments of $260 and it will take you 60 months to pay off the loan completely.
Loan #2 you owe $5000 at 15% and your monthly payment is $120.
Loan #3 is $22,000 at 7% and you are making monthly payments of $435.
Your total monthly payments for the 3 loans are $815 and your payoff time is 60 months.
If you consolidate those 3 loans into 1 at a 8% interest, your monthly payments will be significantly lower at $551 but it will take 96 months to pay the loan back.
Overall you are paying $13,927 in interest payments vs $9,927 if you did not consolidate. So while you are enjoying a monthly payment that is $264 lower, you are making those payments for an additional 36 months and spending a grand total of $4,000 more.
| Loan #1 | Loan #2 | Loan #3 | Consolidated | |||
| $12,000 | $5,000 | $22,000 | Loan Amount | $37,000 | ||
| 11% | 15% | 7% | Interest Rate | 8% | ||
| $815 | Monthly Payment | $551 | ||||
| 60 months | Total Time | 96 months | ||||
| $9,972 | Total Interest Paid | $13,927 |
My experience with debt consolidation
I have personally never consolidated multiple debts in to one but I have taken a loan forbearance which uses the same principle as debt consolidation.
I was in the unfortunate camp.
I had just used up most of my emergency fund on a new apartment and furniture and then I got sick. As the medical bills piled up I began to fall behind.
I missed a few student loan payments and I was offered a forbearance. I thought to myself, this is great, I don’t owe them 4 months anymore, they will start me back at zero and simply tack the 4 months to the end of the loan. They even offered to go longer.
This was over 15 years ago but I can still remember the conversation on the phone as if it were yesterday. The man on the phone seemed so genuine in his concern for me. “If you need to take a few more months to get other affairs in order, that is ok. We can defer up to a year.” Thankfully I decided to just stick with the 4 months I was behind.
Little did I know that I was committing myself to pay back even more money as the interest was still owed and would also be tacked on to the end of the loan as well as more interest for the extra 4 months it would take me to pay off the loan. Overall I would pay them more in total. They weren’t looking out for me, they were working me for even more money.
In my opinion, unless you are so completely desperate that you have no other options, you need to avoid debt consolidation at all costs. Become responsible and use some of the advice offered throughout this website and others to help you clear up your debt fast.
The moral of the story is that there is no easy or quick fix. There is no magic wand you can wave to fix the debt you got yourself in to. You must be responsible and learn from your mistakes.
Once you have cleared up your debt and created responsible habits, you can put yourself on a path to financial independence and early retirement.
Earl