Wednesday, March 26, 2008

Debt Consolidation — Not a Quick Fix

Debt consolidation is very dangerous if you try to use it as a quick fix for your personal credit problems. If you have difficulties controlling your spending, debt consolidation has the ability to make your personal financial problems 10 times worse.


With most traditional consolidation programs, you take a lot of little loans and wrap them up into one big loan–often times with your house as collateral. To make the payments lower, the loan is spread out over many years. So if you have a loan on two cars that total $30,000 and a credit card debt of $20,000 and various other loans for $25,000, you can easily end up with a consolidation loan of $75,000 that is spread out over 30 years. Your payments may seem lower, but you are paying off the debt slower than your assets depreciate. You car is unlikely to run for 30 years. If you drive it for 10 years and then sell it for $1,000 you are still going to owe more money (in the consolidation loan) than the car is worth.

Obviously this is not sustainable. Sure you could try to get another consolidation loan when you by your next set of cars, but this type of strategy makes the debt pile up faster than your ability to pay things off.

Debt consolidation is only useful as part of an overall strategy that includes changing your spending habits. Your goal should be to pay off the consolidated loan as quickly as possible. If you are taking any other approach you are asking for a financial crisis.

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