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Advice On The Disadvantage of Debt Consolidation
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What Is The Definition Of Debt Consolidation
Disadvantages of Consolidating Your Debts
This page is about what the possible disadvantages of debt consolidation can be, so there is an assumption that you already have some awareness of the possible advantages and benefits of the process. The advantages are not hard to come by as they are loudly promoted by the hundreds of companies eager to offer their services to you. The disadvantages take a bit more digging out, so that is what this page is here to help with.
Before we can go into the various ways in which there could be a disadvantage of debt consolidation, it is important to explain that there is more than one way to consolidate debt, and the pros and cons are different depending on which route you choose. The main effect of debt consolidation on the person in debt is largely the same, in that they end up with a single smaller payment, but there are two entirely different ways of achieving this, which can make a big difference.
One way to consolidate debt is to take out a new loan to pay off all your old debts. This leaves you with just a single, more affordable payment to the lender who provides the new loan. The other way is to use a debt management plan, which is about negotiating new terms to repay your old debts, rather than borrowing more money. We will look at these two options in turn and consider the disadvantage of debt consolidation for each method.
Disadvantage of Debt Consolidation Using A Loan
There is a fundamental disadvantage with using a loan to pay off all your debts, and that is the very fact that you are actually taking on new debt. If you get genuinely unbiased advice on the best way to get rid of debt, you will almost never be advised to deepen your debt by taking on even more credit.
The main disadvantages, however, are that you can easily end up making your situation worse if you do not go about this is the right way. Most people do not look further than the fact that their monthly payments will go down, but you need to factor in how long your new loan will last. If you take out a loan that means you pay a bit less each month, but go on making the payments for two years longer than you would with your old debts, you could end up paying far more in the long run.
The other possible disadvantage of debt consolidation in this way is that it is easy to inadvertently end up paying more in interest than you should. A loan company will want you to consolidate all your different debts into the new loan, and this will look sensible as that is how you are going to simplify your debts into a single payment. However, having a single payment does not in itself save you money, it just makes things easier to keep track of, and it is not worth becoming worse off just to achieve that.
The problem is that some of your existing debts may actually be at a lower interest rate than the new loan you are considering, so it is vital that you do not consolidate these debts. Only include in the loan those debts that are at a higher interest rate than the proposed consolidation loan, otherwise you are just swapping your cheap debts for more expensive ones.
The main disadvantage of debt consolidation using a loan is that it is only really effective in a very few situations. It can be useful for paying off debts that are at an especially high rate of interest. It can also be a way to get rid of debts that you cannot include in a debt management plan, such as secured debts. Other than these situations, you are almost always better off with a debt management plan.
Disadvantage of Debt Consolidation Using A Debt Management Plan
When you consolidate debt through a debt management plan (DMP), a negotiator will approach all your creditors to arrange new terms for repaying your debts. This involves reducing interest and other charges, so that what you have to pay out each month is reduced. You then just make a single, reduced payment to the management company, and they have to pass it on to all your creditors.
One disadvantage of debt consolidation through any kind of DMP is that they are not formal or legally binding agreements. While the upside of this is that you can get out of it or amend it quite easily if your circumstances change, the downside is that you cannot force any of your creditors to play ball.
If the debt company manages to get most of your creditors on board, but one does not want to join the plan, there is nothing that can be done to make them join. This is a key difference between debt management plans and IVAs, which are formal and binding. Another consequence of the informality is that you are not protected from being sued if a creditor decides they want to take legal action to recover the debt.
Another disadvantage of debt consolidation through a payment plan is that you are unable to get a plan unless you have a steady income and enough money spare each month to afford the payments. DMPs are not suitable for people in serious hardship who do not have enough money coming in to make any payments towards their debts. If that is your situation you should refer to the IVA page (for UK residents) or the Debt Settlement page (for US residents).
Another limitation is that you can only include unsecured debts in a DMP. While this includes credit cards, store cards, personal loans and other household bills, it does not include any secured debts. Secured debts are those where some asset that you own is used as security. Mortgages and home equity loans are the most common example.
How Do I Get Good Advice?
It is vital to get honest advice on your own personal financial situation, in order to find out whether debt consolidation is likely to be the best solution to your problems. You can do this quickly and easily by applying to a few reputable companies and comparing what they propose.
You can find a list of some of the most reputable debt management companies in the UK and US on the main Debt Management page of this site. You can apply using an online form and they will contact you for more information. You can compare a few because you are under no obligation to accept any offers you receive:
Go To The List Of UK Debt Consolidation Companies
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Find Out More About Debt Consolidation Loans
