Debt consolidation is essentially what the name suggests. It’s bringing all your debts into one place. As you would expect, there are advantages and disadvantages to this approach. Furthermore, if you do decide to go down this path, getting the best out of it requires you to use the right approach for your situation. Here is a quick guide to what you need to know.
The pros of debt consolidation
The main advantage of debt consolidation is that it makes life simpler. Instead of having to manage several different payments, you only have to manage one. That also means you no longer have to think about the best place to make any overpayments you can afford.
This simplicity can bring corollary benefits. For example, it raises your value to the single creditor you use. You may be able to leverage this to your benefit. In particular, you may be able to get a better interest rate. This could give you much-needed breathing space, particularly at times like the present.
Consolidating your debt may also help your credit record. This is particularly true if you have a lot of partly used lines of credit (e.g. credit cards with low balances). Your credit record will reflect the balance you could have if you used your full limit. It can therefore make your situation look worse than it is.
The cons of debt consolidation
The main disadvantage of debt consolidation is that it can actually work out more expensive over the long run. The key point to understand is that the amount you pay on debt is determined by a combination of the interest rate and the repayment term. If debt consolidation leaves you with a longer payment term then you may end up paying more interest even if the headline interest rate is lower.
Debt consolidation can also be much less flexible than your existing debt arrangements. For example, if you currently have credit cards, your only obligation is to make the minimum payment each month. You do not have to pay more but you can if you want to and there is no penalty for doing so. With debt consolidation, you may have a fixed amount to pay per month with no room for variation.
Another point to keep in mind is that debt consolidation isn’t just a debt-management strategy. It’s a business sector. It’s also one where businesses can vary greatly in their quality and affordability. This is not an argument against debt consolidation in itself. It is, however, an argument for being very careful about where you get your advice and help regarding it.
The practicalities of debt consolidation
If you’re considering debt consolidation then your starting point is to make sure that you fully understand your current financial situation. In particular, think about where you would stand if interest rates continued to rise.
If this would see you uncomfortably stretched, then you need to take some form of action now. This does not, however, necessarily mean debt consolidation. You might be able to negotiate a lower interest rate with your current lenders. Even if they do not offer this as standard, they may do so if you can show that you are struggling.
If you do decide to consolidate your debts, then you need to look for the most advantageous way of doing so. If you have a relatively low level of debt then you may be able to consolidate your debt onto a no- (or low-) interest credit-card deal. If you can pay off your debts before the deal ends, you will pay no interest at all.
If this is not an option, however, then you are probably going to be looking at personal loans. In this situation, do your sums very carefully and/or get help. Essentially, you need to find the right balance between giving yourself breathing space in the present and minimising the overall cost of the loan.
