Is Debt Consolidation a Good Idea – or a Trap?

When you have too much debt, or too many credit cards, a debt consolidation loan can look like a good idea. It’s an opportunity to combine multiple loan accounts, and multiple monthly payments, into a single, more manageable payment.

Have you ever heard the saying “if it looks too good to be true, it probably is”? And so it is with debt consolidation loans. They can be a good idea and an opportunity, but they can also be a trap.

debt consolidation good idea

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Before you consider taking a debt consolidation loan, first think long and hard about whether or not you can make it work.

Debt consolidation doesn’t pay off debt

The most fundamental problem – and the issue most likely to trip people up – is the fact that debt consolidation doesn’t actually payoff any debts. It merely rearranges them into a neater looking pile.

The rearranging can actually be an advantage; the problem is in how we see it. A single loan looks contained. It’s less threatening than several loans with various payments. That can make a debt consolidation loan seem almost benign.

It’s important to realize that, just like any other type of loan, the only way that a debt consolidation loan gets paid down is when you take action to do it. Your debt doesn’t magically go away simply because you move it into a prettier looking package.

Consolidations make room for more debt

One of the biggest advantages of debt consolidation loans is also one of it’s biggest drawbacks: a lower monthly payment. That can actually become a problem because once you lower your previous monthly debt payments, there’s a new measure of budgetary freedom that opens the door to taking on new loans.

For example, let’s say you have five credit card accounts with a combined monthly payment of $600, and a total balance of $20,000. You do a debt consolidation loan that puts all $20,000 in plastic into a single loan with one monthly payment of $400. There is now an extra $200 available in your budget.

In a perfect world, you would apply at least some of the $200 in monthly savings to payoff the debt consolidation loan ahead of schedule. But human nature being what it is, this opens up the possibility of taking on new loans.

Since your debt consolidation loan has all of your old debts safely contained, you sort of forget about it, and go back to doing what you’ve always done, and you start hitting the credit cards again. It starts slowly, then gains steam, and before you know it your debt situation is worse than what it was before you took the debt consolidation loan.

The revolving debt consolidation game

You know what revolving debt is – you borrow money, pay some back, then borrow some more. That’s essentially how credit cards work. The same arrangement can develop with debt consolidation loans.

You take a debt consolidation loan to consolidate several credit card accounts, then shortly after that, you start charging on one of the credit cards again. Within two years, you’re still paying the debt consolidation loan, but you now have balances outstanding on several other credit cards. What do you do?

You take another debt consolidation loan.

If the debt consolidation loan gets large enough, you might eventually try to pay it off with a second mortgage or a home equity line of credit. At the extreme, you might try to roll all of your debts into a new first mortgage, thinking that this will be the ultimate solution to your debt problem.

But it doesn’t solve the problem, because debt consolidation loans have become just as revolving as your credit card accounts. And once again, no debts are ever actually paid off – they are simply repackaged.

Debt consolidation’s proper use

Remember at the beginning I said that debt consolidation loans can be a good idea? That IS true, but only if you make it such. A debt consolidation loan should be used as a chance to fix a problem so that you can move forward in life. In order to make a debt consolidation loan work in your favor you need to do the following:

1. Don’t borrow any more money until the debt consolidation loan is paid.
If you have an uncomfortable level of debt, a debt consolidation loan must be viewed as a second chance. It can be very effective at cleaning up past debt problems, but the only way for it to be truly effective is if you stop borrowing money after you take the loan. If you take a debt consolidation loan, resolve that you will not take on any new debt, at least until the debt consolidation loan is fully paid.

2. Pay off the debt consolidation loan as soon as possible.
Since debt consolidation loans typically offer a single monthly payment that is lower than the combined total of payments on several loans, you should use this as an opportunity to payoff the consolidation as quickly as possible. The debts that were consolidated into your new loan represent “past sins”. You should want those out of your life as soon as possible. Also, since debt consolidation loans tend to be fairly large, you don‘t want them hanging around too long anyway.

3. Cut expenses and/or increase income.
The problem of too much debt usually comes about because you are spending too much in relation to the income you are earning. A debt consolidation loan is like a “financial timeout”. It’s an opportunity for you to completely reorganize your finances, and that should include creating a more favorable balance between your income and your expenses.

Use the consolidation as a time to either reduce your expenses, increase your income, or both. Not only will those efforts increase your ability to payoff the debt consolidation loan more quickly, but they’ll leave you in a better financial position once the loan is finally paid. If you’re able to follow through with these principles in mind, then debt consolidation can be a good idea.

Have you used a debt consolidation loan in the past? If so, how did it work for you?

About the Author

By , on Dec 13, 2012
Kevin Mercadante is a professional personal finance blogger, and the owner of his own personal finance blog, He has backgrounds in both accounting and the mortgage industry. He lives in Atlanta with his wife and two teenage kids and can be followed on Twitter at @OutOfYourRut.

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  1. We used the ‘debt snowball’ method suggested by Dave Ramsey and others. Nothing fancy, just followed the plan and have been debt free for years.

    • Kevin says:

      Hi Rod, I think the debt snowball works because of it’s simplicity. It gets the job done in progressive stages where you can see the progress fairly quickly and that motivates you to keep going forward.

  2. Pam says:

    I’ve gotten loans from my bank 3 different times to consolidate. It became a trap for me. Paid them off and recharged every time. Due to a lay off and bad times I have learned my lesson and now I am debt free except for the mortgage.

  3. I think debt consolidation could be good if behaviors change. Otherwise, the debt will just keep repeating.

  4. Thad P says:

    I would think the possibility of predatory practices make this especially problematic.

  5. I tend to agree that debt consolidation can definitely be a trap for some people….especially because those who are likely to do a debt consolidation are those who are already prone to get into debt anyways. It’s just a vicious cycle.

  6. I didn’t use an official debt consolidation program, but I did consolidate credit card debt when I had it–I transferred the balances with a no-fee transfer for 0% for various lengths of time. Throughout it all, I kept making larger payments until I wiped it all out. I agree with your tips–they’re really the only way to go in terms of making something like this successful!

    • Kevin says:

      I think the differnce between you and so many others is that you were focused on the payoff, not so much the consolidation. Debt consolidation loans are tool, not a magical debt cure.

  7. Very nice write up Andy. Your last point is really key. To pay off debt you have to decrease your expenses or increase your income. In today’s world, you almost have to do both – unless you are already making 250k a year 🙂

    • Kevin says:

      Hi Andy, I agree you need to do both. I was being kind in trying to make strategy change seem a little easier. Most people find that they have to do both anyway.

  8. Hi, Kevin, and good article. Yes we have – we consolidated an obscene amount of debt (begative wealth) three years ago – about £100,000 ($160,000) to be precise. We are stone throw from paying it all off – in fact please everyone send a wish/prayer to a supreme supreme being/power of your choice and we may be done by Christmas, What a peesent for ourselves this will be. It work but one has to become really determined to do it and not give up! Once it is done, I am writing the story!

  9. We’ve never had to use debt consolidation before but for some it may be a life saver and for others it could be a trap especially if it’s not their last option> I would make sure I’ve checked everywhere and talked to everyone I could before making any final decisions but everyone’s circumstances are different. Great Post Andy! Mr.CBB

    • Kevin says:

      I think its a viable option IF you’ve first identified and corrected the issues that got you into debt in the first place. Then use consolidation as a way to clean up past mistakes for a better future.

  10. These are very good points! Many don’t realize how easy it can be to accrue new debt once you free up your credit cards by putting them all onto one consolidation loan. Anyone who wants to take a debt consolidation loan should only do so if they are commited to applying any extra money they have from the consolidation onto their debt so it can get paid off quicker. Otherwise, there hardly seems a point in doing it at all.

    • Kevin says:

      That’s so true Shannon. We can never ignore the human factor when it comes to debt. And the human in all of us likes to spend!

  11. Andy Hough says:

    I’ve never had an actual debt consolidation loan before, but I have consolidated my debts on my own. I have had both good and bad results from doing so. The bad results were from not changing my spending habits and just racking up more debt. The good result was when I actually stopped using my credit card and saved lots of interest.

    • Kevin says:

      Hi Andy, Changing your spending habits is the ultimate anti-debt strategy. If you don’t then it’s a battle you can never win.

  12. I made the mistake of consolidating debt and then running the balance back up again. My summer job was only for two months and instead of getting another job, I just lived off my credit card for the remainder of the summer.

  13. I recommend people meet with a credit counselor at a nonprofit agency and learn about a Debt Management Plan (DMP). DMPs offer all of the advantages of a debt consolidation loan–single payment, etc.–but will actually lead to the ‘consolidated’ debt being paid off in 5 years or less, and usually with a much lower interest rate than any debt consolidator will offer.

    I’m not saying debt consolidation is always a poor idea, but in general I will say this: People who are REALLY looking to kick the can of their debt challenges down the road choose a consolidation loan. People who are REALLY looking to pay off their unsecured debt and solve their debt challenges choose a DMP.

    • Kevin says:

      Hi Kurt–I would add that anyone who is serious about beating a debt problem can do it without consolidation. A debt snowball works even better!

  14. I can see both sides of a debt consolidation loan, but as you stated, if you are not financially knowledgeable, then you will be right back where you started. Instead of using a consolidation loan, I just created automatic drafts for my credit cards to pull from an account that I setup. I paid one fee into the account, then the auto drafts took place on their due dates. I only saw the one payment and didn’t have to log in to each account. It worked for me!

  15. Mackenzie says:

    I’ve never used debt consolidation, but I knew someone who did. And like others have stated previously, they did not learn their lesson. They spent more money and racked up more debt. More cards and they were in the same boat again, a short time later.

    • Kevin says:

      Hi Mackenzie–Debt consolidation is treated too much like a get-out-of-jail-free card. It really should be seen as a time out to fix your debt problem.

  16. I’ve made all of said mistakes in the revolving debt category. Moved credit card balances to cards with lower interest. Got married then combined both of our cards and a car loan onto a HELOC. Just last week, got a new first mortgage in which we rolled in the balance of the HELOC.

    It’s absurd to think that I’ll be paying for those meals out and all the CD’s I bought during college, as well as for the Jeep I don’t even own anymore, until my house is paid off!

  17. I love this post. I’ve never used debt consolidation, but I’ve known several people that continually roll their consumer debt into their MORTGAGE and then proceed to max out their credit cards again. Ridiculous!

    • Kevin says:

      Hi Jordann–That’s what I saw again and again in the mortgage business. You have to treat consolidation as a mini bankruptcy in order for it to work the way it should.

  18. Matt says:

    Couldn’t have put it better myself.

    Personally, having arranged these loans in a previous job, I’ve seen the pro’s and con’s first hand. Some companies are wise enough to pay the loan out in cheques made payable to the other lenders, rather than just making the cash available. What would be better though, is some kind of warranty whereby the paid off accounts are shut down, thus preventing a repeat of history.

    Unfortunately this repeat of history does happen a lot, although there are times when people just don’t help themselves. One example of many I remember was: arranging a loan, and part of the process was a property evaluation (these were secured loans). The customer’s credit check had come back with mortgage arrears on it, yet the valuation had a photo of the house – with a 2 year old Audi TT on the drive… Doh!!

    Perhaps IQ checks should also be included in loan applications…

    • Kevin says:

      Hi Matt, I’m with you, I saw this all the time in the mortgage business (we were often the last stop before bankruptcy court!)

  19. I know of one particular family member who got in over their head with credit and had all of their debts consolidated into one simple payment through a lending company. They however never learned financial responsibility and I believe they are still in heaps of trouble financially. The debt unfortunately is like a vicious cycle that they now are trapped in.

  20. Pauline says:

    Like credit cards, consolidation is designed to make you pay more but you can outsmart the system if you keep your level of repayments, or at least do not enjoy the extra room in your budget to take on some more debt. If everyone did that, they wouldn’t offer those loans anymore, like credit cards wouldn’t have rewards if everyone paid them in full.

  21. Eddie says:

    The nice thing about consolidating your debt is that you get one payment. So it simplifies things. The downside is that its only a ban aid on the situation. In Canada many consolidate their debt into their mortgage, and then see all this available credit….and you know what happens next. It can be a vicious cycle.

    • Kevin says:

      Hi Eddie–Band aid is a perfect description. Consolidations rearrange debt, which can help sometimes, but it doesn’t make it go away.

  22. I’ve not used a debt consolidation loan, but I did have my credit card debt consolidated years ago. The nice thing was that it knocked down the rate on many of the cards and I only had one payment to make. It allowed me to get the debt paid off and nothing was being loaned to me. It also allowed for there to be no black mark on my credit report for doing so, not that it wasn’t already in dire straits anyway. 🙂 Thankful I had access to the program as it helped me get out of debt.

    • Kevin says:

      Hi John, You found one of the better companies then. They’re not all that good! You also stuck with it, which is the key.

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