Debt consolidation can sound like a great idea. Roll all your liabilities – especially the credit cards and personal loans at high rates – into one easy to manage repayment on a (usually) cheaper rate.
Consolidating debts can be great if managed correctly, but managed poorly can lead to a worse position than before.
Important considerations when consolidating debts:
• How did you get here? It’s critical to understand how you arrived at three maxed out credit cards and a large personal loan so you don’t end up there again.
• Don’t be tempted to leave cards open. If you can, pay off AND CLOSE all but one credit card. It might make sense to keep one card for emergencies, payments which require a credit card and for accumulating reward points. Consider reducing your credit card limit.
• Mismatched loan terms. I’m a believer that loan terms should match the useful lifespan of what it was used for. This is why car loans are over five year terms and not 30. A mismatched loan term could mean paying for something long after its usefulness has expired.
• The interest rate illusion. Don’t be fooled that rolling your debts onto a low home loan rate will cost less. Typical interest paid on a $30,000 five year car loan is around $6,000. Adding $30,000 to your home loan for 25 years could cost more than three times that.
Cash flow and convenience are the two key benefits of consolidating debts.
One easy to manage repayment; and reduction in the amount spent each month on loan and card repayments.
A successful debt consolidation comes down to what you do with that extra cash. So before you consolidate make sure it’s part of a plan to improve your financial situation and not one that will make it worse.