3 Signs Debt Consolidation Isn’t the Right Option for You
Debt consolidation can give your finances a fresh start. If you’re sitting atop a mountain of considerable debt, combining it into one payment can help you get back on track — but it isn’t for everyone.
If you’re thinking about taking this step, you’ll need to choose from a debt consolidation loan, credit card balance transfer or a home equity loan. On the surface, this might seem like the obvious choice, but it’s not that simple.
“There are several potential downsides to a debt consolidation loan that you’ll need to consider before you apply,” said Martin Lynch, president of the Financial Counseling Association of America (FCAA).
It’s important to educate yourself on the potential negative aspects of this popular financial move. To get you started, Lynch shared three signs that debt consolidation isn’t the best choice for you.
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You’re Not Prepared for a Hard Credit Inquiry
“There will most likely be a hard inquiry on your credit report, and you’ll lose some points off your FICO score,” Lynch said. “While the point loss is relative to the amount of information in your credit report at the time you apply, it hurts if you suffer the damage and your loan application is denied.”
Consequently, before you apply for a loan, he said it’s important to do your homework to gauge your chances for approval.
You’re Not Prepared To Pay Loan Fees
“Your savings will be offset a bit by the cost of the loan itself,” Lynch said. “Origination fees for consolidation loans can get pricey — up to 10% of the loan amount — so do thorough research on the actual costs before you commit.”
He added that there’s more involved with a debt consolidation loan than simply getting a better interest rate. If you’re considering a zero-percent balance transfer card, he said the same would be true. “You’ll probably pay a fee on the amount of the balance you transfer onto the 0% card — usually in the 3%-5% range,” he said.
You Haven’t Learned From Your Mistakes
“The biggest pitfall has less to do with numbers and more to do with the consumer’s behavior,” Lynch said. “After some borrowers take out their new consolidation loan and see their credit card balances paid to $0, they go on a spending spree.”
This, of course, would make your debt consolidation loan relatively useless.
“At that point, they’ll have to make the monthly payment on the consolidation loan and make their regular credit card payment every month,” he said. “If you’re going to take out a loan to pay off your credit card balances, you should stop and think about how those balances got so high in the first place.”
He said to really think about whether you’ve learned your lesson or if you’re just setting yourself up to learn a more painful lesson down the road. He said participating in a free counseling session — such as one offered by the FCAA — can be invaluable.
“They aren’t lenders and they won’t judge your behavior,” he said. “But they will make sure you’ve considered your spending habits and have a strategy in place to make the best use of your loan proceeds, helping you avoid the cycle of debt that consolidation loans can lead to.”
Ultimately, debt consolidation can be a good choice for your finances, but it isn’t right for everyone. Take the time to conduct thorough research and be honest with yourself about your plans — if any — to make positive changes, so you don’t end up in the same or worse financial situation down the road.
This article was provided by MoneyLion.com for informational purposes only and should not be construed as financial, legal or tax advice.
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