Juggling multiple debt payments each month can be tough, so offers to consolidate your debt into one lower monthly payment can be pretty enticing. But is taking out a debt consolidation loan a good idea?
Short answer: It depends.
Debt consolidation loans are designed to allow you to pay off your outstanding balances at a lower interest rate and to do so with a single monthly payment that is easier to manage. The problem is that those nifty lower rates are harder to come by these days thanks to risk-adverse lenders and the continuing credit crunch. The loans that are available likely will require collateral and have much higher interest rates than before, in some cases as high as 25 percent.
With rates like that, your lower monthly payment may come at too high a price.
“If you belong to a credit union, you might want to look there [for a lower rate]. You might also want to look at some of the social lending Web sites,” said Gerri Detweiler, credit adviser for Credit.com. “But make sure you are not paying a higher interest rate for a lower payment, so it costs you more in the long run.”
Another option for consolidating debt is transferring your individual balances to a credit card with a lower interest rate. Again, good rates are scarce. And there’s another risk: compounding your debt.
David Jones, president of the Association of Independent Consumer Credit Counseling Agencies, said too many consumers fall into the trap of running up the paid-down credit cards, ending up with more debt. Jones said consumers must be disciplined and focus on paying down their debt at the lower rate while refraining from using the old cards.
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“If you charge up all your other cards after you’ve paid them off, all you end up with is new debt and a new card,” Jones said.
Gail Cunningham, vice president for public relations for the National Foundation for Credit Counseling, agrees.
“You can play the balance-transfer game, and you can win it, but you have to stay on top of things and read the fine print. [Balance-transfer offers] are fewer and fewer and have higher fees associated with them,” she said. “The consumer needs to understand that moving debt around is not the same as reducing debt.”
A less risky option for consolidating debt is entering into a debt-management plan with a certified credit counselor. Under a debt-management plan, you repay all of your debt with lower interest rates and fees negotiated through a credit counselor. The counseling agency makes arrangements with your participating creditors. In return, you make one monthly payment to the agency that is distributed to your creditors.
For recommendations on a credit counselor, try the Association of Independent Consumer Credit Counseling Agencies at aiccca.org or the National Foundation for Credit Counseling at nfcc.org.
Detweiler said a debt-management plan is the better option for many consumers.
“You’ll be on a plan that will get you out of debt within five years, and you can’t charge anymore because you’ve closed your accounts. So you can’t dig yourself into a hole,” she said. “And you get some advice on your spending and budget while you’re at it.”
If you decide to take the debt consolidation route, be careful to avoid advance-fee loan scams, which consumer advocates say are on the rise. Any loan offer that requires you to pay an upfront fee, guarantees you a loan for a price or mandates credit insurance as a condition of the loan is likely fraudulent, experts say.
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