What Are the Pros and Cons of Consolidating Debt?

Debt consolidation refers to the act of taking out a loan to pay for a series of debts (most likely other loans). If a large loan can be obtained, the person can then pay all other debts with that money and then only have to worry about repaying the single loan taken last. If a large loan cannot be obtained from a bank or financial institution because of bad credit, a loan consolidation company may take over the debts and offer the loan, at usually a higher interest rate.

Significance

The main benefit of debt consolidation is the lower monthly payments. When the debt consolidation company refinances your debt, it secures an agreement with your debtors to save you money and reduce your interest rates. From that moment on, you are only obligated to make a single monthly payment to the debt consolidation company, who in turn will pay your debtors. As long as your payments are on time, the numbers will always be lower than you would pay if you were to cover each debt separately.

Function

Another important benefit of debt consolidation is simplicity. If you are handling numerous debts, you are more likely to get confused, miss a payment or forget to account for a bill, especially if payments come at different times throughout the month. When you consolidate debts, you write a single check every month and the consolidation company takes care of the money distribution for you.

Potential

Some types of debt consolidation qualify you for tax breaks. This is especially true of home consolidation loans, which allow you to use your house as a collateral for the loan and in return allow for tax deductions over mortgage. On the other hand, any loan tied to your house presents a risk, as you can lose the property if you default on payments.

Expert Insight

Experts believe the major risk of debt consolidation is that it provides you with an apparent easy way out, which teaches you nothing about handling your money and may put you in even larger debt if you don't pay the consolidation loan on time. If you take a credit card loan to pay your debts, you will be paying higher interest rates. Still, it is easy to default on payments and start accruing new debt.

Warning

Debt consolidation may seem cheaper at first sight, but it will end up costing you more in the long run. For starters, when you combine debts, you get an average percentage for all of them. If you have large debts that only have a small percentage, it would actually be cheaper to pay those on your own rather than combining them with debts that have a higher percentage. Also, you will now be paying for a debt consolidation loan, which can have a lower or higher interest rate depending on your credit history.