Is A Debt Consolidation Loan A Bad Idea?

by Ron Haynes

No, not necessarily, but there are some inherent problems that must be dealt with before I would ever advise someone to get a debt consolidation loan.

Unless the problems that created the need for a debt consolidation loan are corrected, you may well find yourself worse off in the long run. If the debt resulted from overspending, then a consolidation loan won’t help, rather it will just delay the inevitable. Otherwise, in about a year or so, those little bills will be back again and when they are now combined with the debt consolidation loan payment, may make your cash flow problem even worse.

The other problem is that there is always the tendency to stop worrying once the supposed solution has been found. Many people actually spend more the month after consolidating their debts than they ever did before. Why? The pressure is off and they can now relax. That is a false security created by the temporary removal of financial pressures.

The third problem is people almost always borrow more than they actually need to pay their outstanding debts. Guess what happens next? Here come the entertainment systems, the new living room furniture, the vacation to the Bahamas. Once again, the lack of self discipline rears its ugly head.

So, let’s suppose you’ve been on a budget for six months (minimum) to one year. You’ve disciplined yourself to resist urges to spend money during that time and you’ve maintained on time payments to your creditors. If those apply to you and a consolidation loan will free up some cash flow to help you create an emergency fund or just give you some breathing room, what are some options to get that debt consolidation loan?

1. Peer to peer lending

Perhaps the most preferable of all situations, borrowing from a peer to peer site such as Lending Club allows you to get a rate that’s affordable and probably much better than any bank. With Lending Club, you can get personal Loans of up to $25,000 with rates as low as 7.88% if you have good credit.

2. Credit unions

If you are a member of a credit union, you’ll find that loans are a little easier to get and the rates are a little better than many other sources.

3. Pledged collateral

Many banks will lend at very good rates with in-bank deposits (such as CD’s) used as collateral. Obviously, those needing debt consolidation loans rarely have cash available for collateral, but many times a family member will. This will require a high degree of trust and the person putting up the collateral should monitor the situation very closely.

4. Cash value life insurance

Money in cash value life insurance can usually be borrowed at a very good rate. You might not have this type of insurance, but a parent might.

5. Family

Granted, this is a tough situation and many relationships have been damaged by a family member’s failure to meet a financial obligation. If you’re asked to lend, I would only recommend “loaning” money you can easily afford to lose, otherwise that Thanksgiving turkey might have a funny “twang” to it. If you borrow from a family member, make certain you pay back everything you should. Never compromise doing what’s right to do something that’s more convenient.

Loan Options I Would Avoid

  • Borrowing from my retirement account – the fees, the taxes, and the loss of growth make this almost as expensive as pay day loans.
  • Pay day anticipation loans – with interest rates in the stratosphere, using one of these lenders is financial suicide.
  • Borrowing on a credit card – they’re probably what you’re trying to consolidate anyway. Don’t make things worse.
  • Home equity – with the volatility in real estate, borrowing against it could mean having my loan “re-called” if my home’s value drops too low.

Again, only use a consolidation loan if you’ve been on a budget for at least six months and preferably a full year. It takes that much time to develop the good habits that will help carry you through to the last payment on that debt consolidation loan.

About the author

Ron Haynes has written 1000 articles on The Wisdom Journal.


The founder and editor of The Wisdom Journal in 2007, Ron has worked in banking, distribution, retail, and upper management for companies ranging in size from small startups to multi-billion dollar corporations. He graduated Suma Cum Laude from a top MBA program and currently is a Human Resources and Management consultant, helping companies know how employees will behave in varying situations and what motivates them to action, assisting firms in identifying top talent, and coaching managers and employees on how to better communicate and make the workplace MUCH more enjoyable. If you'd like help in these areas, contact Ron using the contact form at the top of this page or at 870-761-7881.


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{ 4 comments }

Michael Harr @ Wealth...Uncomplicated

Solid post. I’d add that if someone does pursue a debt consolidation loan, they should take it two steps further. First, close all associated credit accounts that created the ‘need’ for a consolidation loan. Second, freeze your credit to make it more difficult to acquire credit (this doesn’t ding you necessarily, but it can help to reduce your likelihood of falling back into bad habits). By freezing your credit, you also reduce solicitations arriving via postal service.

Generally speaking, most are better off not consolidating because the psychology of consolidation puts them in worse shape than simply digging in and paying things off one bill at a time. With the current environment, creditors are more willing than ever to deliver favorable payment arrangements with account holders–particularly those with heavy debt loads.

Jeff@MySuperChargedLife

Ron – Back a few years ago, I took out a home equity loan to consolidate several debts into one loan. I did it for all the wrong reasons (i.e. lower interest rate, lower monthly payment, etc.) Fortunately, shortly afterwards, I read Total Money Makeover by Dave Ramsey. This saved me from digging myself a deeper hole. Today, we are debt-free except our mortgage. It took my wife and I almost two years to pay off our consolidation loan. I was sure glad to see that sucker die!

Danielle

I might be a bit late to the party, commenting now that it is June, but I have a strong opinion about this.

I agree with your ideas that a consolidation loan will not do you any good if you don’t fix the underlying problems, however I don’t agree that a consolidation loan, peer to peer or borrowing from family should be considered before balance transfers to another card.

If you have good enough credit for any of those other options, you should also be eligible for balance transfer rates. Even in todays “credit crunch” I get offers for 0% for 7 months, 2.9% for 12 months. How can these tools be overlooked as options. The way credit cards apply your payments to the highest rates first there is a strong discouragement to using the card.

SmartBrains

I agree with this thought … Is A Debt Consolidation Loan A Bad Idea … It is worse … If you take out a loan then you put yourself in trouble … So avoid the loan …..
Thanks

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