Why Debt Consolidation Doesn't Work

When you're drowning in debts, consolidating them may seem like a good solution. By transferring all your credit card bills to one low-interest card, taking out a low-interest home-equity loan to pay off your other bills, or working with a debt consolidation service, you end up with only one payment to make each month, and at a lower interest rate. Consolidation doesn't eliminate your debts, however, and ultimately may not help you.

Costs

Debt consolidation may reduce your interest payments, but you'll pay for the privilege, the Federal Trade Commission states. If you get help from a debt-consolidation service, the company charges a fee; if you take out a home equity loan, you'll have to pay the lender. Depending on the services you're using and who you're dealing with, the total costs could be several hundred dollars or more added onto your existing debt load.

Habits

For many debtors, the problem isn't just the money they owe, it's the spending habits that created the debt load. If you have a problem with overspending and don't fix it, consolidation isn't going to change anything, because you'll continue to spend more than you have. According to financial coach Dave Ramsey, 78 percent of the people who go through debt consolidation wind up over their heads because they don't stop spending and don't save for emergencies, which then have to go on the credit card as well.

Size

Consolidating your debts makes paying them easier, but it doesn't make the total debt load any less. If you're in over your head with bigger monthly payments than you can afford, you're still going to be over your head after you consolidate. Some debt-consolidation firms negotiate a lower payment by stretching out the payments over a longer term; that makes it easier on you month to month, but you'll be in debt even longer.

Considerations

If you sign up for a debt-consolidation plan, it can hurt your credit score almost as badly as bankruptcy. If you fail to complete the plan, that will also ruin your credit, and you'll be at risk for defaulting on your loans. Another problem is that debt-consolidation services aren't binding contracts: Some of your lenders may refuse to cooperate, or back out partway through the plan.