Debt consolidation involves taking out a low-interest loan and using that to pay off your higher-interest obligations. Essentially, with debt consolidation you're moving all of your debt to a single low-interest creditor to reduce your monthly payments. While consolidation can help you get out of debt faster, it has to be seen as one part of a complete debt management strategy -- not as a magic bullet that will take care of all of your financial woes.
Debt Consolidation Companies
There are many for-profit debt consolidation companies that seem eager to give you a loan to pay off your high-interest debts. MSN Money personal finance expert MP Dunleavy cautions strongly against using a debt consolidation company's services. In return for giving you a consolidation loan and negotiating lower rates with creditors, you'll have to pay the debt consolidation company a fee, likely rolled in with the single monthly payment that it quotes you. It's not smart to pay someone to do what you could do on your own: get a consolidation loan through your bank and talk to creditors about lowering interest rates and payments. Furthermore, Dunleavy warns that consolidation companies sometimes pay creditors late or miss payments altogether, which hurts your credit score. It's a safer move to take money matters into your own hands.
Debt Management Companies
These outfits are similar to debt consolidation companies, minus the low-interest loan. They work to make your financial situation a bit more comfortable by negotiating lower interest rates and longer debt repayment terms. According to top-selling personal finance author Dave Ramsey, using one of these services kills your credit rating. Apply for a mortgage after going to a debt management company and you'll be treated the same as someone who filed for bankruptcy.
What You Should Do
According finance expert David Bach on the money and personal finance website Wallet Pop, debt reduction must be accompanied by changes to your spending habits. Don't rely on debt consolidation alone to get you out of a sticky situation, but make it part of an overall debt reduction plan. Stop falling victim to "buy now, pay later" marketing schemes. Stop using your debit and credit cards altogether for awhile, until you get your spending situation under control. Create and stick to a cash budget for your regular monthly expenses. Call creditors on your own and negotiate lower interest rates. Don't be shy. If you've always made at least the minimum payment to your credit card company on time, you have grounds to request a lower interest rate. Visit your bank and see if you can qualify for a low-interest consolidation loan. Move as much of your higher-interest debt over to this loan as you can. Finally, focus on paying off just one creditor at a time. Work on wiping out your highest-interest debt first, making the minimum payment on your other loans in the meantime.
If You Need Help
Not all organizations designed to help you get out of debt are bad. It's the for-profit ones that you need to be wary of. If you're looking for advice about what to do, David Bach suggests turning to nonprofit counseling agencies. These include the National Foundation for Credit Counseling and Association of Independent Consumer Credit Counseling Agencies, which can provide referrals to reputable financial professionals.
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