The Dark Sides of Debt Consolidation

With the lowest record interest rates seen in decades, it is economically feasible for a person deep in debt to consolidate all of his debts into 1 single monthly payment at a lower interest rate. This is what debt consolidation essentially does. However, that is NOT all you need to be debt free, you have to do a lot more. You have to focus on saving up more money by lowering your monthly expenses and accelerating the debt repayment process.

Here are a few pitfalls that could make your debt consolidation program fail and put you in more debt:

1) Debt Repayment Period

When paying off their debts, consumers have their minds on only 1 thing, and that is the monthly payments. Some debt consolidation companies will therefore lower your current monthly payments, which is nice, but they will also stretch your payback period. For example, say you are currently paying $560 per month for 48 months (for a debt balance of $26,000). Some shady debt consolidation companies will help lower your monthly payments to something like $450 a month (woohoo!), but they will also stretch your payback period to 68 months! In this case, you'd end up paying $30,600!

You will basically end up paying more in the long term for the same amount of loan, just that your short term debt obligations (your monthly payments) will be reduced.

If your debt consolidaton company is really out there to help you reduce your debts, they will lower your monthly payments by lowering the interest rates and also NOT stretch your payback period (it must remain the same).

2) Change Your Spending Behaviour

After you enter the debt consolidation program and pay lower monthly payments, it is very important to NOT rack up any more debt, and instead save up as much of your money as you can. Open a savings account with a 5% interest rate from ING Direct or HSBC Online (5.5%) and save all your money there.

Whilst in the debt consolidation program, you should avoid going to luxury restaurants, malls, resorts and use your plastic to rack up more debt. If you do this, your debt consolidation efforts will FAIL!

Carrying higher debt loads and attaching to them your personal assets as collateral is even more dangerous. For example, if you refinanced your debts using a home equity line of credit loan only to use your plastic to rack up more debt, you would be in additional debt and this time around, there is no 2nd debt consolidation program. You will instead lose your home!

3) More Principal, Less Interest

A debt consolidation program is favourable in the sense that you have more disposable income left over whilst your monthly payments are reduced. This creates the opportunity for you to pay off your debt faster by deploying whatever money is saved up towards the Original Principal of your debt. As more payments are applied towards the Original Principal balance, the interest you pay is lowered every single month. This creates a faster debt reduction process and you can get rid of your debt much faster. Like we said earlier, this process can be made even more faster if you apply whatever savings you have left over to pay off the Original Principal balance.