Pros and Cons of Debt Consolidation

_{By Bromwich+Smith Staff | 1550 words | Reading Time: 7 minutes and 36 seconds | Date: 2021/11/23}

When you start to think about how to deal with your debt; the first thing that may come to mind is a debt consolidation loan. Debt consolidation loans are used to pay off multiple debts, combining monthly payments into one and in most cases with a lower interest rate. This can sound like an ideal solution but as always we want you to be informed in terms of determining if this is the right course of action for you. Let’s start with defining a debt consolidation loan along with outlining the pros and cons of choosing debt consolidation for yourself. 

What is a debt consolidation loan?

A consolidation loan is a loan or line of credit that takes other loans, credit cards and debts and rolls them into one payment.  Essentially, it is borrowing money to pay off borrowed money.  With one consolidation loan, you have a set interest rate and one payment rather than several payments to several debtors with various interest rates.  In most cases you can keep your old credit or debts.  In some cases, you will be required to close access to your old credit cards and debts.

Please keep in mind that not all consolidation loans offer a better or lower interest rate.  If you have been late on your debt payments in the past or your debts are in collections at the time you are searching for a solution, a high interest consolidation loan may seem like your only option. 

When you consolidate your debts, you are paying off the full amount plus interest. In order to qualify for a consolidation loan, the lender will check your credit and want to know your income, expenses, assets and liabilities to assess the risk of lending money to you. Once you are approved, you are bound by your contract with the lender to make your payments including interest for a set period of time.

Types of credit you can include in your consolidation loan

With major banks and financial institutions, you can usually consolidate most of your credit card balances and lines of credit.  In most cases Student loan debt cannot be included but in all cases CRA is not included.  

Impact on your credit report

The consolidation loan provider will check your credit, so there will be an additional inquiry on your credit report which may impact your score.  The number of inquiries on your credit report can have an impact on your overall score.  At the same time, your consolidation loan will be visible on your credit report so making your monthly payments will be crucial.  As you pay your consolidation loan down, your credit score will improve eventhough it will take a hit initially as you close your other credit products. Ideally, it still puts you ahead of the game. 

Pros of debt consolidation

Debt consolidation is often the best way for people to get out of debt. Here are some of the main benefits we would like to share with you:

1. You can repay debt sooner

Taking out a debt consolidation loan may help pay off your overall debt faster, especially if you have significant credit card debt. Credit cards don’t have a set timeline for paying off a balance, but a consolidation loan has fixed payments every month with a clear beginning and end to the loan.

2. You can simplify your finances

When you consolidate debt, you no longer have to worry about multiple due dates for debts as you will only have one monthly payment to make. As well, the monthly payment is the same amount each month, so you know exactly how much money to set aside.

3. You will get a lower interest rate

Rates can vary depending on your credit score and the loan amount and term length, but you’re likely to get a lower interest rate with a debt consolidation loan than what you’re currently paying on your credit card.

4. You will have a fixed repayment schedule

If you use a personal loan to pay off your debt, you’ll know exactly how much is due each month and when your very last payment will be. Paying only the minimum with a high interest credit card can take years before you pay it off in full.

5. Boost credit

While a debt consolidation loan may initially lower your credit score as you go through a hard credit inquiry, a debt consolidation loan may help improve it over time. That’s because you’ll be more likely to make on-time payments. Paying a single monthly bill when it’s due should significantly raise your score.

Cons of debt consolidation

There are also some downsides to debt consolidation that you should consider before taking out a loan that we would like to share with you as well: 

1. It won’t solve your financial problems 

Consolidating debt does not guarantee that you won’t go into debt again. If you have a history of living beyond your means, you might do so again once you feel free of debt. To help avoid this, make yourself a realistic budget and stick to it. You should also start building an emergency fund that can be used to pay for financial surprises so you don’t have to rely on credit cards.

2. You may have to pay up-front costs

Some debt consolidation loans come with fees. These may include:

• Loan origination fees.
• Balance transfer fees.
• Closing costs.
• Annual fees.

Before taking out a debt consolidation loan, ask about any and all fees, including those for making late payments or paying your loan off early.

3. You may pay a higher rate

Your debt consolidation loan could come at a higher rate than what you currently pay on your debts. This could happen for a variety of reasons, including your current credit score. Extending your loan term could get you a lower monthly payment, but you may end up paying more in interest in the long run. As you consider debt consolidation, weigh your immediate needs with your long-term goals to find the best solution.

4. Missing payments will set you back even further

If you miss one of your monthly loan payments, you’ll likely have to pay a late payment fee. In addition, if a payment is returned due to insufficient funds, some lenders will charge you a returned payment fee. These fees can greatly increase your borrowing costs.

5. Not all debt can be included

Student loans in some cases can be included but are most likely not. CRA debt is never included, so you will want consider wither a consolidation loan will move you out of debt and and closer to your goals. 

Also, since lenders typically report a late payment to the credit bureaus after it becomes 30 days past due, your credit score can suffer serious damage. This can make it harder for you to qualify for future loans and get the best interest rate.

To reduce your chances of missing a payment, enroll in the lender’s automatic payment program if it has one.

Please watch for up-front fees, high interest rates and be sure to select a reputable company by researching them and reading reviews. Ultimately, you need to be realistic about your strengths and weaknesses and choose the solution that has the best chance of being sustainable.  

Discussing your options with a Licensed Insolvency Trustee at Bromwich+Smith can help make sure that you don’t rush into a loan without weighing all the pros and cons. 

Should I consolidate my debt?

This really depends on your circumstances. That said, we thought we might share some scenarios to help you determine if a debt consolidation loan makes sense:

1. You have a good credit score: If you have a good credit score you’ll have a better chance of securing a lower interest rate than you have on your current debt, which could save you money.
2. You prefer fixed payments: If you prefer for your interest rate, repayment term and monthly payment to be fixed, a debt consolidation loan might be right for you.
3. You want one monthly payment: Taking out a debt consolidation loan could be a good idea if you don’t like keeping track of multiple payments.
4. You can afford to repay the loan: A debt consolidation loan will only benefit you if you can afford to repay it. If you can’t, you’ll risk digging yourself into a deeper financial hole.

Final considerations

Before signing onto a debt consolidation loan, review all of your current monthly minimum payments and the expected length of time to repay the debt and compare that to the time and expense associated with a consolidation loan.

And remember, when considering debt consolidation, reflect on what the root causes have been to get to this point.  Debt consolidation can feel like an immediate relief, but it may not resolve the problem if there are issues such as overspending that remain unaddressed.

We’re here to help by offering an initial free, no obligation, confidential consultation by phone 1.855.884.9243 or video. You can also request a call back at our contact us page, live chat, or connect with us through chat. Our team of Debt Relief Specialists will assist you with unbiased and nonjudgmental support, ensuring you find the right solution that will help you conquer your debt and rebuild your worth today.