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Understanding the risks of debt consolidation

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Taking out one big loan to consolidate all your high-interest debt can seem like a dream come true. After all, you have the potential to go from having multiple payments down to just one and secure a lower APR. In the end, that means you could save money on interest and get out of debt faster. What could go wrong?

Actually, a lot can go wrong if you don’t fix what needs to be fixed.

Debt consolidation is a lot like having gastric bypass surgery in that sense. You get a new lease on life and you can lose weight, but it’s not a permanent fix if you don’t change your eating habits.

When debt consolidation makes sense

Debt consolidation can make sense for anyone struggling with high-interest debt and multiple balances they want to consolidate. However, it works best for people who are ready to make a lifestyle change so they can avoid winding up in the same situation over and over again.

Here are some other signs debt consolidation may make sense:

  • You have medical bills to consolidate and need some time to pay them off
  • You have too many bills coming in and you want to consolidate down to one
  • You have good or excellent credit, so you can qualify for a debt consolidation loan with the lowest interest rate and best terms
  • You have a plan in place to get out of debt and stay out

Consider all your debt consolidation options before you pull the trigger. A personal loan can make sense if you want a low fixed interest rate and a fixed monthly payment, but don’t want to put your house up for collateral.

A balance transfer credit card can also work well for debt consolidation, but only if you have a plan to pay off your balance before your 0% introductory offer ends.

The problems with debt consolidation

One major problem with debt consolidation is that it can free up “space” for consumers to rack up even more debt.

Imagine someone who consolidates $20,000 in high-interest credit card debt with a debt consolidation loan, but they never stop using credit cards for their spending. In this case, they might wind up having to pay off the debt consolidation loan and an ever-rising mountain of new credit card debt.

They may have simplified their repayment process, but not addressing the core problem of spending beyond their means leaves them worse off than when they started.

Another issue can come about when consumers use their home equity to consolidate debt. Home equity loans are attractive, since they let consumers use their home’s value as collateral for the loan, thus securing a lower interest rate in the process. They also offer fixed interest rates and fixed monthly payments, making them easy to plan for.

But, consolidating debt won’t help if you don’t have a plan to avoid racking up more. And seeing your credit card balances go down to zero might make you feel secure in some extra spending, leading to a new stream of debt and money woes. But in this case, the homeowner is a lot worse off than when they started because they chipped away at their home equity. If they don’t repay all they owe, they could lose their home to foreclosure.

Then there are balance transfer credit cards — or cards that offer 0% for a limited time. These offers can be tempting since they let you avoid interest for a long time — even up to 21 months — but they won’t eliminate debt. And if you don’t take debt repayment seriously and pay as much as you can, a balance transfer credit card is nothing more than a temporary break from a higher interest rate. Once your introductory offer is over, you’re back where you started.

Long term success means changing habits

Debt consolidation can make paying off debt easier if you can qualify for a lower interest rate and better terms. And since many personal loans for debt consolidation come with rates as low as four percent with no origination fees or hidden fees, they can easily save consumers thousands of dollars and months of payments.

However, a debt consolidation truly paying off depends on your habits moving forward. In other words, to get out of debt and stay out, you have to stop digging.

The Federal Trade Commission (FTC) says using a monthly budget is the best way to take control of your financial situation. A good first step is to make a realistic assessment of your earnings and spending each month, and making any needed adjustments.

The goal of this is simple – making sure your income is covering your needs, while deciding how to best allocate any remaining funds. Some of it should likely be set aside for savings, but you’ll need to use some for debt repayment, too.

No matter which debt consolidation method you use, you should do whatever it takes to avoid more debt. That could mean making dramatic cuts to your spending so you can live within your means.

Bottom line

Debt consolidation can help you pay down debt, but it takes more work on your end to be successful. Decide which debt consolidation option might work best for your needs, and move forward once you understand the risks.

Written by
Holly D. Johnson
Author, Award-Winning Writer
Holly Johnson writes expert content on personal finance, credit cards, loyalty and insurance topics. In addition to writing for Bankrate and, Johnson does ongoing work for clients that include CNN, Forbes Advisor, LendingTree, Time Magazine and more.