People who are struggling to pay their debts may think using one loan or a line of credit to pay off several debts is a quick fix for their financial problems. Those methods may work for some people, but others find themselves deeper in debt due to the high-interest charges that often come with loan and credit card consolidation options.
Debt Accumulation
Debt consolidation often involves taking on more debt to solve a financial problem. Yet that can create more problems for consumers who don't reduce their spending and change other behaviors that created their financial troubles in the first place. A Bankrate.com article, "Debt Consolidation: Cure or Continued Credit Problems?" says 70 percent of Americans who get loans to pay off credit cards accumulate the same amount of debt or more within two years. Furthermore, people who need loans to solve their debt problems probably won't get low interest rates on their loans. Lenders give the best rates to people with high credit scores, and large amounts of credit card debt usually lowers a borrower's score.
Home-Equity Loans
Homeowners who are deep in debt may be able to get home equity loans to pay off their credit cards, but the loans aren't a good option in some circumstances. Home equity is equal to the appraised value of a home minus the balance owed on a mortgage, and people who've lived in their homes for many years may have a lot of equity available. However, homeowners who end up in more financial trouble and fail to pay back the home equity loans they used to consolidate their credit card debt could default on their loans and lose their property.
Credit Card Transfers
Some people use credit cards to consolidate debt by transferring balances from high-interest cards to low-interest ones. Their intention usually is to reduce their interest charges while they pay off their cards. However, credit card companies usually offer low interest rates for a limited amount of time to people who transfer their balances from other cards. Cardholders who don't pay off their balances before those low rates expire could end up paying the high interest rates they were trying to avoid. Cardholders who are late with a payment after consolidating their credit card debt can be hit with penalty interest rates that exceed 20 percent.
Debt Management Plans
Debt management plans offered by nonprofit organizations such as the National Foundation for Credit Counseling may be a better option than debt consolidation loans and credit card transfers. People who enroll in debt management plans typically meet with a credit counselor who helps them create a budget and a debt repayment plan. According to the Bankrate.com article, someone with $20,000 in debt could save more than $10,000 in interest payments and fees by working with a counselor to pay off credit cards rather than taking out a debt consolidation loan. Credit counselors can save their clients money because they typically negotiate with creditors to reduce the interest rates and fees their clients are charged.
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