7 Things to Know Before Consolidating Bad Debt

7 Things to Know Before Consolidating Bad Debt

Before talking to anyone about debt consolidation, be prepared with these 7 important facts.

From cookies to cars, everything you buy has the potential to become debt. Most things in life can be had with the quick swipe of a credit card or, in the case of your car, an easy loan. While that’s definitely a convenient perk of living in the 21st century, it can also be a dangerous trap to fall into if you’re not careful.

There are plenty of helpful articles out there that define and describe debt consolidation. But we want to present seven things you should know before you choose that option. Being well-informed with these seven principles will put you in a better position to decide.

After all, just as no two people are alike, your financial problems are unique, too. And the way you choose to solve them will have a big impact on your life. Whether you end up choosing payday loans, a personal loan, credit counseling, or a combination of solutions, your main objective is to avoid letting your debt spiral.

With that in mind, here are seven things you should know.

1. Debt Consolidation Does Not Eliminate or Even Reduce Your Debt

What many people overlook about debt consolidation is that it’s a way to move your debt around but it’s not a way to reduce the debt. It’s not ‘debt settlement”, either, which is when you pay a company to negotiate with your creditors for a reduced total payment.

2. Your New Interest Rate Depends on Your Credit Score

Another misconception is that debt consolidation is just like refinancing a home mortgage: you do it for the lower interest rates. Nope- you’re not even guaranteed a lower interest rate on your newly-consolidated debt. Your rates are determined by your credit score, which, if you’re reading this, probably isn’t very good.

3. The Interest Rate Also Depends on Your History

Let’s face it — if your debts are causing you problems, then it’s a safe bet to say you don’t have much in your savings account. And we’re guessing there’s not much of an emergency fund in your financial portfolio, either. You could even be on the road to bankruptcy.
So you’ve probably missed a few payments here and there, which is an interest rate-killer. Your new interest rate will be affected by your payment history so be prepared and don’t expect lower interest rates.

4. Ironically, it Might Cause You to Go Further Into Debt

One thing that consolidation does is take your credit card debt and move it all to one place. That frees up your old credit cards, tempting you to use them again. So when you start using that newly-paid-off Macy’s credit card again, you’re piling on more debt.

5. It Could Hurt Your Credit Score

Here’s another reason that freeing up your old lines of credit is dangerous. If you continue to use those old credit cards that got you into trouble in the first place, you’re raising your credit utilization ratio.

Credit reporting agencies like Experian and Trans Union use that ratio to determine your credit score — and the lower the better. Being tempted to use those cards again, thus raising your ratio, will lower your FICO credit score.

6. Debt Consolidation Won’t Help Much if You Don’t Change

By consolidating your debts, you are solving financial problems that arose from your past mistakes. But if you repeat those mistakes in the future with the same bad money behavior, nothing’s really changed.

Good personal finance is based on good money habits, which means you’ve got to change the way you think about money and debt.

7. You’ll Remain in Debt Longer

Debt consolidation means you’ll be taking on a new loan. It’s a refinanced loan that looks good on the surface because it lowers your monthly payments. But all that means is that the term of your loan has been extended. And in the eyes of any financial advisor worth their salt, staying in debt longer isn’t the path to financial health.

A Final Word

The truth is, debt consolidation isn’t always the best choice. And there are several alternatives, including payday loans, installment loans, or a personal loan. These may not be right for you either. But unlike debt consolidation, they can be used to help pay off your bills. And that, in the end, is your real goal!