By Lama Farran
Having multiple loans and credit cards to pay off can be a sure recipe for overwhelm and insomnia. This is when your financial institution will recommend applying for a debt consolidation loan. I often get asked the question if a debt consolidation is a good thing or a bad thing. My simple answer is: it’s both!
In plain English, a debt consolidation means that you get one loan to cover the balances of multiple loans that you have. For example, let’s assume that you have a retail store credit card with a balance of $2000 at 29%, a credit card with a balance of $3000 at 19.9% and a line of credit with a balance of $5000 at 10%. You can apply for a debt consolidation loan of $10,000 to pay off all 3 debts. Most probably the rate on the consolidation loan will be much lower than the interest rates you are currently paying and you will have only 1 payment each month, instead of 3 different ones. Of course, before approving you, the loan manager will take into account many factors, such as your credit rating, how well you paid back your debts in the past, your existing salary and your other large expenses, such as rent or mortgage and car loan.
Given that you save on interest cost and you are given a determined period to pay off your loan, debt consolidation is a “good thing”.
So why would I think it can also be bad?
Because , during my banking years I witnessed numerous times the number 1 danger of debt consolidation: People do not question how they got into debt in the first place and they don’t have a plan for how they will adjust their financial behavior going forward. One of my favorite quotes says: “the only real mistake is the one from which we learn nothing.” This is where I believe debt consolidation is a “bad thing”. When you don’t change any of the behaviors that led you to being in debt, you are almost guaranteed that you will find yourself in the same situation in a few years.
Therefore, if you just went through a debt consolidation, it is crucial that you take the time to reflect, investigate the reasons you got into debt and establish a detailed action plan to prevent yourself from being in the same situation again. Such an action plan can include steps like tracking your expenses and adjusting your spending month by month; or you can commit to saving for anything that you wish to buy, instead of putting it on your credit card and figuring it out later. So you can live by the motto “Save now, buy later”, rather than “buy now, pay later”.
In summary, debt consolidation by itself is not a bad thing. It can sometimes be a necessary and helpful step in your debt-free journey. However, it can easily become a bad thing when you don’t learn your lesson, you don’t change any of your spending behaviors and you soon find yourself in the same situation again.
Lama Farran is a passionate Certified Money Coach, on a mission to help individuals/families take control of their finances and budgets, without selling any financial products. She is now offering a Free Money Guide on her website www.maxworth.ca . She can be reached at firstname.lastname@example.org (514) 717-1976.