When is Debt Consolidation Wise?

Rule #1 of debt consolidation is that you should NOT do it if your primary motivation is to reduce the number of payments you have to send every month. Setting up automatic drafts from your checking account and/or making use of the online bill paying features that most banks offer is a great way to eliminate a lot of the bills you need to pay while making sure that you avoid late fees and that you are always making timely payments.

Rule #2 of debt consolidation is that the main goal should be to reduce the total amount of interest/fees you pay. For this reason you will only want to consolidate loans that have higher interest rates/fees than the loan that you plan to use for consolidation. To roll lower interest payments into the loan will mean that you are paying more than you absolutely need to in order to repay the same amount of debt. For example, many auto companies are offering very attractive 2.9% loan options to those who finance through them, you would not want to roll that 2.9% loan into a 7.9% loan, no matter what your lender tells you.

Rule #3 when it comes to debt consolidation is to look long and hard before you leap. It is one thing to reduce the amount of your monthly payments by lowering the amount of interest you pay and another to lower your monthly payments by getting into loans with longer terms. You will end up paying more over the course of your loan when you extend the length of time for repayment. The only time that extending the term of repaying back your debt is an acceptable situation is when you cannot afford to live comfortably (not excessively) with your bills as they are and must reorganize your debt in order to recover.

Now that you understand these three important rules use the loan calculator to see how much you will really be paying if you consolidate your debt into a one loan.

Finally, if you want to consolidate your debt by using your home as collateral (i.e. increasing the amount of money you owe on your home) thru refinancing or by taking an additional home equity loan / line of credit, then you should weigh the expected savings in interest charges relative to the additional risk that you will be taking. In other words, if you think that after you consolidate the chances of you being able to make the new monthly payment is low then it is best not to consolidate and keep your home as secure as possible for the time being. Credit card companies are unlikely to go after your home in order to collect on their debt. On the other hand if you get in over your head by consolidating at the wrong time or irresponsibly your mortgage company will foreclose in order to cut their losses.


Your Financial Ally