Debt Consolidation: 10 Pros and Cons

[Jan 30, 2009.]

 

Debt consolidation occurs when a borrower rolls up a number of short-term, unsecured loans (credit card, store accounts, personal loans and so on) into one larger, long-term, secured loan.

Pro #1
For anyone with serious financial problems, debt consolidation can relieve stress and bring peace of mind. It often provides a manageable way forward when everything seems helpless.

Con #1
Those with the biggest problems, and the worst credit ratings, may not qualify for a debt consolidation loan, or may have to pay high interest rates for one. If turned down for debt consolidation, they should consult a trained and certified credit counselor, and consider a debt management program (DMP).

Pro #2
Debt consolidation will normally reduce total monthly outgoings. Because repayments are spread out over a longer period, they are typically significantly lower.

Con #2
The downside of having a longer-term loan is that the total interest payable over the life of the debt is usually higher than that for shorter ones.

Pro #3
It is much easier to manage a single loan than multiple ones. Instead of having to juggle lots of different creditors, many of whom will be asking for different amounts each month, the borrower has to make just one, predictable monthly payment. So budgeting becomes much simpler.

Con #3
The process of consolidating debt does not in itself solve problems. Real benefits only arise when a borrower combines debt consolidation with better budgeting, and improved money management.

Pro #4
Debt consolidation can provide a breather during which a poor credit rating can be repaired. Instead of having multiple arrears reported by multiple lenders, a prudent borrower's credit report shows a single monthly payment being made on time. However, ExpertLaw says that, in the short term, a debt consolidation loan can actually harm a credit rating, depending on how it is scored.

Con #4
Credit card debt and personal loans are usually unsecured, while debt consolidation loans are typically secured. That means that borrowers are putting up their houses as collateral when they take out a debt consolidation loan. And their homes are at risk if they fail to keep up repayments. This is a very important point, which should be considered carefully.

Pro #5
If borrowers who have only one loan find themselves in financial trouble again, then they have only one lender to negotiate with. The usual torrent of harassing calls from many different credit card and loan companies is avoided.

Con #5
A debt consolidation is a long-term commitment. Borrowers should ask themselves whether they want to take on a loan that they may be paying off for many years.


Everything in life has pros and cons, and debt consolidation loans are no exception. It is generally a bad idea to take one out as a way of extending credit and increasing overall indebtedness. However, for those who are willing to budget prudently they can be an excellent way to address debt issues.

 

About Author:

Peter Andrew has been writing about -- and for -- business for more than two decades. For the last couple of years, he has found himself increasingly specializing in the U.S. financial sector.