What Is the Fine Print to Debt Consolidation?

Debt consolidation can be an easy way to reduce your monthly payments, simplify your finances and getting out of debt in general, but you have to be sure to read the fine print, or else you could end up in worse straits than you are now. The fine print to debt consolidation will depend on what type of debt consolidation method you use.

Credit Cards

When you consolidate your debt, you change the way your credit is utilized. Credit utilization is how much of your credit you are using; so, if you have $25,000 available credit spread across three accounts and your total balance is $15,000, you are at 60 percent credit utilization. The lower your credit utilization rate the better. If you opted to consolidate all your debt on to one credit card, your credit utilization rate will increase, unless you only consolidate your credit card debt, and your credit score will take a hit as a result. This effect will be magnified if you close any credit card accounts after consolidation.

Equity

If you used an equity-based loan to consolidate your debt, like a home equity loan or cash-out mortgage refinancing, the biggest risk is that if you fail to make your payments, you will lose your home. Further, when you use the equity in your home to consolidate your debt, you may have to pay points; a point is 1 percent of the amount you borrow. While you may enjoy certain tax advantages using equity to consolidate your debt, those advantages may be offset once points are considered.

Debt Management

If you are considering consolidating your debt using a debt management agency, be aware that such programs carry their own risks, even those that claim to be "nonprofit." Aside from the fact that there are many companies offering debt management services that are not legitimate, when you ask someone else to manage your debt for you, there will be costs involved for the administration of your account at a minimum. Moreover, many debt management companies offer you a lower monthly payment and a reduced interest rate by spreading your payments over a longer period, so what may have taken you two years to pay off, now takes six, for example. Further, if the debt management agency is extending you a loan, interest rates can be high on average, even starting low and growing over time.

Bankruptcy

Bankruptcy, or more specifically a Chapter 13 bankruptcy, can be used to consolidate debt. Under a Chapter 13, your debts are placed into a three- to five-year debt repayment plan; secured debts are paid first, and any remaining income after your living expenses is meted out to your unsecured debt creditors, such as your credit card company. The advantage is that any debts you cannot repay are discharged, so long as they are not exempt from discharge under the bankruptcy code. Further, your monthly payments are capped at what you can afford after paying for your living expenses. However, bankruptcy as a debt consolidation method has consequences: your credit score will be impacted, making it difficult to obtain new credit, buy a home or vehicle, get life insurance, get a job or promotion, secure a lease, etc., and your ability to save will be seriously hampered for the duration of the debt repayment plan (usually three to five years). As such, if your car breaks down or your furnace breaks, you may not have the money to pay for repairs nor be able to secure financing or a loan to cover them.