When Getting a Debt Consolidation Loan is a Bad Idea

Debt consolidation loans allow you to pay off multiple debts with a single loan, reducing your monthly payments to one and often reducing your interest rates. You will only gain these benefits if you fall into the minority of people who have the financial profile to require debt consolidation. Otherwise, you may end up in a bad financial situation.

Moving Debts to a Higher Interest Rate

First, you must have multiple debts in order to have a debt consolidation work for you. The debts will not all have the same rate, some debt companies may charge up to 5% higher rates than others. Your intention will be to move all of your debts to a new, lower interest rate.  If you consolidate with a rate that is higher than some of your loans, do not move this debt to the consolidation rate because you will end up spending more over time.

Calculate the total cost of paying off your debts at the existing rates. Then, calculate the cost of paying them off with the new rate. The consolidation loan should be less; otherwise it will cost you more over the life of the loan to consolidate. Also, consider only consolidating those loans which have very high rates.

Paying High Penalties

The consolidation loan you get will be used to pay off your existing debt with a lump sum. You may face large fees to pay these off early. Auto dealership loans are notorious for having very high early-payoff fees. Make sure you are using your debt consolidation loans to pay off your existing debt at a lower total settlement; otherwise, you will be paying off the entire debt plus fees and penalties. A good debt consolidation company should be able to settle your debt at a low rate. If you cannot do this, you should walk away from the deal.

Seeking a Loan or Mortgage Soon

Your credit score will take a hit anytime you enter credit negotiation. Settlement and consolidation is not looked upon highly by lenders who will end up making less than they bargained for off your loan. They would like you to pay off the loan in full when it matures and also pay any fees and penalties for late payments. Since you are not doing this, your credit will take a hit. If you have this mark against you right before seeking a large loan or mortgage, your new interest rates will be astronomical. In some cases, you will not even be approved for the loan.

Can Pay the Debt through Other Means

If you can pay off your loan without consolidating, you should. Paying off loans on time is the best way to build your credit. Most people seeking consolidation have poor credit or late payments on their records. By eventually recovering from the situation and paying the loans off, they can show financial health to potential future lenders. Seeking debt consolidation when you are down at the bottom will show you dug a whole you couldn't get out of.


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