Debt consolidation has a number of advantages for consumers trying to get a handle on their debt. However, many factors should be weighed and lifestyle changes made before embarking upon a debt management program.
Debt consolidation loans are obviously designed to consolidate all of your debt under one loan so you will only have to keep track of one payment each month. This is also intended to place high-interest credit card debt under a lower interest rate so you will end up paying less in the long run. Many people use home equity loans for this purpose so they can also deduct the interest from their income taxes—something you cannot do with most other types of debt.
When you consider that you can end up paying a lot less interest by consolidating your higher-interest debts under one lower interest rate, debt consolidation sounds great. It's also more convenient to have only one debt payment to worry about each month, rather than a bunch of payments with different due dates. Plus, you may end up with a lower monthly payment for the combined debts than what you are paying each month now.
The problem with debt consolidation, however, is that you are taking a number of unsecured debts and putting them into a secured loan. This means that, if your financial situation worsens, you lose your job or you have a major medical expense, you will still be responsible for paying the consolidated debt—even if you file for bankruptcy. If you have used a home equity loan to consolidate your debt and are later unable to pay, you could lose your home.
Bankruptcy stays on your credit report for at least 10 years post-discharge. This can greatly complicate your ability to obtain credit at a reasonable interest rate, and a bad credit score can increase your car insurance rates no matter how well you drive and how few accidents you have had in your lifetime. This is why many people choose to consolidate their debt rather than file for bankruptcy.
Those who consolidate their debts must be prepared to make changes in their lifestyle to prevent themselves from getting back into debt on top of what they have already consolidated. For instance, once you have consolidated your credit card debt, cut up all your credit cards so you won't be tempted to use them. If you feel that you must keep one for emergencies, keep it locked up or frozen in a block of ice so you will have to let it thaw before you can use it. This should help keep you from misusing it.