Debt consolidation is often one of the first ideas that come to mind when you’re overwhelmed by debt.
But how does it work, and is it a good idea to consolidate your debt?
I’ll cover how debt consolidation works in a bit, but first let’s think about this a little. Because your approach and the reasons behind it matter.
Suppose you’ve got 5 credit cards, a car loan, and a student loan, and you’re tired of all those payments.
You’ve got the internet right here, so what are you going to search for? Will it be “debt consolidation” or will it be “how to get out of debt”?
The average searcher
If you’re like most people, you’ll search for debt consolidation. In fact, that may even have been how you found this article.
Google tells me there are more than six times the number of searches each month for “debt consolidation” compared to “how to get out of debt”.
That means way more folks are searching for ways to lump their debt together.
Because at it’s most basic level, that’s what consolidating debt does. It takes multiple loans and puts them into one. And that could be a good thing or a bad thing, depending on your goals and where you’re at in your debt payoff journey.
Debt consolidation vs. how to get out of debt: Why your choice matters
You might be wondering why it even matters which phrase you search for. The answer is simple: we search for the solution to what we see as our problem.
If you think your problem is that you have too many payments…
If you think your problem is that you have too many payments, you’ll look for a way to reduce the total number of payments. In other words, you’ll try to find a way to put all your debt into one giant pile so that you “only” have to make “one easy payment”.
You’ll still have all that debt though. It’ll just be organized differently.
And if you’re like most people, before you know it you’ll be even further in debt because you haven’t changed your mindset and your habits. This is where debt consolidation can go very wrong.
If you think your problem is high interest rates…
If you think your problem is that your interest rates are too high, you’ll look for a way to pay less in interest. Paying less interest can be great!
But reducing the interest may or may not help. It depends on where you are in the process, and what your goal is. It depends on what you do going forward.
(A quick note: High interest rates probably are making the problem much worse if you are talking about payday loans. In that case, interest problem really is a part of the problem and it’s worth doing whatever you can to pay them off faster. But the rates are not the only problem.)
If you think having debt is the problem…
On the other hand, if you think your problem is that you’re in debt, and you’re ready to buckle down and do what it takes to get out, that’s actually great.
Because you’ll look for a way to solve the real problem — not just a way to make continuing to have the problem a little less painful.
In other words, you’ll look for a way to pay off what you owe for good vs. a way to move it around.
And once you’ve changed your habits and are no longer borrowing money for any reason, THEN debt consolidation might make sense.
How debt consolidation works
On the surface, debt consolidation seems simple. You take out a separate, larger loan and then use the money you get from that large loan to pay off your existing smaller loans. (Which are typically credit cards.)
The idea is that instead of multiple bills with a variety of interest rates, you get one bill and one (ideally lower) interest rate.
It seems easier to manage, and the average interest rate may actually go down. The term may be longer too, giving you more time to pay off the new loan, and possibly also a lower monthly payment.
Is debt consolidation a good idea?
Depending on your circumstances and the type of debts you have, it may or may not be a good idea to consolidate your debt. Let’s talk about the pros and cons for the two major types of debt people often want to consolidate:
Consolidating federal student loans
There are a few pros if you’re thinking of consolidating federal student loans.
For example, you might be able to turn variable interest rate federal student loans into fixed-rate ones, which could be a good thing depending on future and current rates. If you have trouble making payments on time, reducing the number of late payments you end up making (by reducing the number of loans) would be beneficial. You also don’t need to pay a fee to consolidate them, because it’s done via the StudentLoans.gov site.
But there are also several cons for federal student loans.
You might end up paying more interest because you extend the time it takes to get them paid off. Or worse, you might lose borrower benefits or credit toward loan forgiveness.
Be sure you completely understand any potential downsides and their long-term implications before taking this step.
Consolidating private student loans by refinancing them
Private student loans may come with higher interest rates than federal ones, depending on when you took them out and the current rates.
So it COULD make sense to do so if it will help you pay them off faster. (Especially if you’re done with school & no longer taking out new ones.)
Check out this post on refinancing your student loans for some of the pros and cons you’ll want to think about in that case. And if you’re interested in doing so, here’s a list of some of the best student loan refinance companies and services.
Consolidating credit cards & other consumer debts
Now for the biggie. Put simply, it’s hardly ever a good idea to consolidate credit cards and other consumer debt. Here’s why.
Mathematically, it certainly seems like a good idea. Having fewer payments to worry about and a lower overall interest rate sounds like a no-brainer. It’s all very logical.
But that’s exactly the problem. When it comes to debt, we aren’t logical. If we were, we wouldn’t be in debt in the first place.
If I offered to sell you a sandwich for $10 today or for $14 tomorrow, would you choose to pay the $14? Of course not. It’s not logical.
But somehow we’re fine with swiping the card and paying “nothing” right this second, but $14 (or more!) later. Our emotions — our hunger for the sandwich or our desire to have something right now — override logic.
We don’t get into debt logically, and we can’t get out of it that way either — at least not at first.
What happens if we try to do so by consolidating debt too soon?
Often we end up even deeper in the hole than we were to start out with, because moving our debts around does nothing beyond giving us a false sense of relief.
We feel like we paid off the credit cards and car with our debt consolidation loan. We may even joyfully tell people that “we paid off our car!”, but the truth is, we didn’t pay off anything.
We still owe the same amount of money. We’re just paying a different company.
That makes debt consolidation is an unfortunate bandaid.
The really bad part is, we feel better. The debt is no longer pressing the way it once was, even though we still owe the same amount.
Let’s face it: most of us don’t do anything about a problem until we can’t stand it any longer.
So we don’t change anything about our behavior.
And the next time we need money, we do what we’ve always done. We borrow more.
Consolidating debt can make things worse
Before we know it, we owe even more money. We’re right back where we started with multiple loans and multiple interest rates. Except this time it’s actually worse, because the total amount we owe is higher.
This is especially bad if we consolidated debt by taking out a home equity loan. In that case, we traded unsecured debt for debt on our home, making it possible for the lender to take our house if we aren’t able to pay for some reason.
We can’t see the future, so it’s a huge risk.
I know, I know. You’ve got more self control than that. You’ll be the exception. Except you almost certainly won’t be, just like I wasn’t.
On the plus side…
On the plus side, getting out of debt is not about self-control. It’s about changing the things you do and the way you view borrowing money — long term.
Make your changes first, and then consider a consolidation loan — if you still want to — once you’ve has at least a solid year of real debt reduction under your belt.
That’s when debt consolidation can be a good idea: when you KNOW it can help you reach your goal faster because you are already making progress at tackling the real problem.
When you’re no longer borrowing for emergencies or anything else. When you’re using money you already have instead. Then it can help.
The first change to make is no longer looking toward debt for the answer.
Because the answer lies within you. With the changes you make going forward.