Consolidating debt is a lot like sorting dirty laundry: You’re not improving the situation, you’re just moving things from one pile to another.

“If you don’t deal with the behavior that got [you] there in the first place, you’re not solving the problem,” says consumer adviser Clark Howard, co-author of
Clark’s Big Book of Bargains.

But if you’re in great shape financially, have no problems paying the bills and have an emergency fund set aside, you’re a good candidate for consolidation — and you have more options.

To consolidate or not to consolidate
Decide what you want to achieve with consolidation. Do you want to lower your interest rates? Do you want to lower your monthly payments? Or just stretch out the terms on your loans? If it’s one of the last two, tread carefully.

“If you really want a get-out-of-debt-free card, you’ve got to understand how you got into the mess and fix the mess,” says Wayne Bogosian, co-author of
The Complete Idiot’s Guide to 401(k) Plans.

“People solving symptoms with debt consolidation are on the verge of making the problem worse,” he says.

There are three ways to lower your monthly payments: qualify for a lower rate, put up collateral to reduce the risk and the rate, or stretch out the term of the loan, says Bill Hampel, chief economist with the Credit Union National Association.

If you now qualify for a lower rate with your creditors because of falling rates or better credit, “this is a perfect example of how consolidation can help you,” Hampel says.

But consumers need to remember that the debt, even at better terms, is still there. And they still have to be diligent about paying it off before they add to it.

For a smart move, look at what the consolidation will cost you for the total life of the loan, not just the monthly payment, says Todd Mark, spokesman for
Consumer Credit Counseling Service of Greater Atlanta. And tread carefully.

“Consolidation is so dangerous, especially for the typical consumer we see,” he says. “After consolidation, they get a false sense of relief. So often the worst cases we’ve seen are people who have consolidated into their mortgages.”

Consolidation also can hurt your credit score if it involves a credit card, home loan or line of credit, says John Ulzheimer, business development manager for
MyFico.com, a division of Fair Isaac Corp., the company that developed credit scoring.

“Debt consolidation always has an effect on the credit report, so it always has an effect on the credit score,” he says. Just how much the score will change, and for how long, depends on your report and how you treat your consolidation loan.

Want to gauge just how much that new card or loan could affect your credit? Go to the
Fico Score Estimator at Bankrate.com. Calculate your score with and without the consolidation option.

If you’re consolidating because you’re in financial trouble, liquidate other assets first says Ric Edelman, author of “Financial Security in Troubled Times.” “You should not have money in assets if you also owe money in debt,” he says. Three exceptions: mortgages, car loans and student loans.

But Bogosian disagrees. “Never use an appreciating asset to get rid of a depreciating asset,” he says, adding that he’d tap life insurance first, if possible.

Bottom line: Weigh the options carefully and do what will work best for you. And shop carefully.

What kind of consolidation loan should you tap?
If you have a plan for whittling down your debt and consolidation is part of it, what options should you tap? That depends on who you ask.

Rolling a handful of high-rate credit cards into one or two with better terms “works for people who have a certain amount of debt but aren’t in the red zone,” says Travis Plunkett, legislative director, Consumer Federation of America, a nonprofit advocacy group.

To avoid being late with payments, set up an automatic bank draft or e-bill payments to cover the minimums, says Howard.

Many financial advisers will caution against taking out a loan with the house as collateral, even if you’re doing well financially. Others don’t want to see consumers robbing their futures (retirement accounts) to get out of trouble now. And some believe it’s a big mistake to trade asset producing accounts (like investments) to pay off debt.

Last year, 44 percent of consumers taking out home equity loans and 35 percent of those tapping home equity lines of credit used the proceeds to consolidate debt, according to figures from the Consumer Bankers Association. And the amount consumers accessed with cash-out refinancing shot from $26 billion in 2000 to $138 billion in 2003, according to figures from Freddie Mac. But consumers may be making a big mistake in tying their debts to their homes, according to several money experts.

If you’re already in financial hot water, you’ve got to be more careful in choosing a method to consolidate your debt. When you’re already having problems making your payments, you never want to take out a loan or line of credit against your home. “That’s playing with fire,” says Howard.

Edelman agrees. “You’re in debt because you bought too many sweaters with your Visa card,” he says. “There’s nothing Visa can do about that. But once you tie your house to that, you can lose your house.”

And too many people return to their old spending habits. “You’re likely to build the debt back up again, only this time you won’t have the equity to bail you out,” Edelman says.

Look at your situation and protect what’s most important for you and your family. Sometimes making some cutbacks (cable, shopping, etc.) and putting the extra money toward bills will be enough. You may decide to tap savings or investment accounts, rather than add more debt with a loan. And you might want to get some advice from a financial planner or debt counselor.

When it comes to debt counselors, “there are two kinds: nice ones and bad ones,” says Hampel. “As long as you pick a good one, you’re OK.” His advice: stay away from the ones who advertise on late night TV.

Going on a debt management program at a credit counseling center “almost always has a negative effect on the consumer’s [credit] score,” says Ulzheimer. Just how much “is a crap-shoot,” he says. But if your score is already bad, it’s not going to make that much of a difference.

If you’re deciding between consolidation options, rank your financial priorities. Which assets are vital to your survival and untouchable? Which can you live without? If the house is more important than the retirement account, you might decide that if you go for a loan, that’s what you’ll tap. But if your job is iffy, your health is good and that old life insurance policy is just gathering dust, selling or borrowing against it might be the best option for you.

If your consolidation is an attempt to stave off bankruptcy, you don’t want to do anything that would make things worse if you do have to file later. In most cases, certain assets, like homes and 401(k) accounts, are protected in bankruptcy. If your creditors can’t touch them in a situation as dire as bankruptcy, do you really want to hand them over now?

Whichever solution you choose is likely to cost you something somewhere. So if you decide on a consolidation option, shop carefully. With loans and credit, get at least three quotes. Look at a variety of venders. Banks, credit unions and finance companies may see you differently. With a bank, you could have an ongoing relationship, which could help you. Credit unions tend to give a better break on rates and fees. And finance companies sometimes market themselves to consumers with flawed credit.

But too many times, consumers are grasping at options that will only make things worse. “A lot of debt consolidation loans are really
home equity loans or second mortgages,” Plunkett says. And even borrowers who don’t own a home have to be savvy so they don’t get lulled into a bad consolidation deal, he says.

And don’t act out of fear or stress. A couple of late payments on credit cards might screw up your credit for a while, but it won’t kill you. Keep a roof over your head, food on the table, the power on and the health insurance paid. Everything else is negotiable.

“A lot of times, when you’re offered these debt consolidation loans, oftentimes you’re so anxious to get instant relief that you’re not even being a savvy consumer and considering what would be the best terms for you,” says Mark.

Some of the options consumers will see “don’t even pass the smell test,” says Bogosian. “Use your common sense.”

Dana Dratch is a freelance writer based in Atlanta.