Pros and Cons of Debt Consolidation

3.9.2023 | Category: Article

Debt consolidation is a financial tool that involves taking out a new loan or credit card account to pay off multiple debts, such as high-interest credit card balances, school loans, or medical bills. 

While debt consolidation may not be the right choice for everyone, it can offer several benefits for those struggling to manage their debts. It can make the interest rate on multiple debts average lower, make payment schedules manageable and improve credit over time. It can also provide peace of mind by simplifying the process of paying down debt. 

Consumers can choose to apply for a personal loan to consolidate their debt or work with a company to consolidate their debts on their behalf. If you have average or better credit, you can often negotiate lower rates on balance transfers to consolidate your debt. 

However, if your credit is below average, you may want to consider paying off one or two lines of credit and improving your score before working with a debt consolidation company. There can often be further negative impacts to your credit as debt is considered “settled” rather than “paid in full” by some credit reporting agencies when you work with a company to consolidate or negotiate debt. 

To understand if debt consolidation is the right choice for you, here are some pros and cons of debt consolidation. 

The Pros Of Consolidation Debt 

Simplified payments

Having multiple debts can be overwhelming, especially if they have different interest rates and payment schedules. Debt consolidation simplifies your payments by combining all your debts into a single loan or credit card account, with a single payment to make each month. This can make it easier to manage your debts and avoid missed payments.

Lower interest rates

One of the primary benefits of debt consolidation is the potential to lower your interest rates. If you have high-interest credit card debt, for example, consolidating it with a personal loan or low-interest credit card can help you save money on interest charges. This can also help you pay off your debts faster, as more of your payment goes toward the principal balance.

Improved credit score

Another benefit of debt consolidation is the potential to improve your credit score. If you have multiple high-interest debts, your credit utilization ratio may be high, which can negatively impact your credit score. Consolidating your debts can lower your credit utilization ratio and improve your credit score over time.

Fixed payment schedule

Debt consolidation loans often come with a fixed payment schedule, which can make it easier to budget and plan for your payments. With a fixed payment schedule, you'll know exactly how much you need to pay each month and for how long, which can help you stay on track with your debt repayment plan.

Reduced stress and anxiety

Managing multiple debts can be stressful and overwhelming. Debt consolidation can help reduce stress and anxiety by simplifying your payments and giving you a clear path toward debt freedom. By consolidating your debts, you can focus on making a single payment each month and make progress toward paying off your debts.

The Cons Of Debt Consolidation

May increase total interest paid over time

While consolidating your debts can help you get a lower average interest rate, it can also extend the repayment term, resulting in more interest charges over time. One of the potential downsides of debt consolidation is that it may increase the total amount of interest you pay over the life of your loan. Be sure to understand your loan’s terms before agreeing to avoid paying more interest over the life of the loan. 

Can hurt your credit score temporarily

When you apply for a debt consolidation loan, the lender will likely perform a hard inquiry on your credit report. This can temporarily lower your credit score, as too many hard inquiries can be viewed as a sign of financial distress. Additionally, if you close credit card accounts after consolidating your debt, it can lower the average age of your credit accounts, which can also negatively impact your credit score.

Requires discipline and self-control

Debt consolidation can only work if you're committed to making your payments on time and avoiding additional debt. If you continue to rack up credit card debt or miss payments, debt consolidation will not solve your financial problems and may even make them worse. Be sure you’re ready to stick to a budget to pay down your debt for good and reach your financial goals.

May come with fees and penalties

Debt consolidation loans may come with fees and penalties, such as origination fees, balance transfer fees, and prepayment penalties. These fees can add up over time and increase the overall cost of your loan. If you have better than average credit, often times these costs are negotiable. Do your diligence and apply with a lender that offers you the best options for consolidating your debt without additional costs. 

Debt consolidation can be a useful tool for managing debt, but it's important to be aware of the potential downsides. Before pursuing debt consolidation, consider whether it's the right choice for your financial situation and whether you're committed to making the necessary lifestyle changes to achieve long-term financial stability.

There are many ways to consolidate debt, from credit card balance transfers to personal loans, consolidation programs to even tapping your home equity to pay down debt. If you’re ready to wrangle your debt, be sure to explore all your options for your financial future.