Debt Consolidation – The Truth
Is debt consolidation a good thing? Not exactly. The myth about debt consolidation is that it saves you money by having less interest and one smaller payment. In reality, you haven’t really done anything to help your debt problem. Essentially, all you have done is move your debt from one lender to another. It is not exactly the brightest financial planning one can do.
Why do you think there are companies out there that offer debt consolidation? Because they are making tons of money doing them! What happens is they lower your interest rate to attract you with a smaller payment, but they increase the term of the loan. If you stay in debt longer, you end up paying the lender more money.
So, how do debt consolidation companies make their money? Let’s say you have $100,000 in unsecured debt divided up into 2 loans. One loan is a 10 year loan for $60,000 at 10% and the other is a 8 year loan for $40,000 at 12%. Your monthly payments are $792.90 and $650.11 for a total of $1,443.01 per month. Let’s say a debt consolidation company offers you one loan with a lower monthly payment of $1,014.27 at an interest rate of 9%. This is a very attractive offer. That is $428.74 less per month. However, they don’t tell you that it will now take you 15 years to pay off the loan. So instead of paying a total of $176,528.16 for your previous 2 loans, you are going to pay $182,568.60. That is $6,040.44 more money that you pay for the same debt. Doesn’t sound nearly as good does it?
Here’s a staggering statistic about debt consolidation. After someone consolidates their debt, 78% of the time their debt will grow back. Why? Because debt consolidation doesn’t fix the spending problem. You are in debt because you spend more money than you take in. If you don’t change your habits, you aren’t going to change your financial health.
To really get out of debt, you need a plan. You need to live on less than you make and try to earn some extra money to start paying off the debt. The key is changing your habits and getting on track to a healthier financial future.