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Debt consolidation has helped many people get their financial lives back on track after being overwhelmed by the sums they owe to their creditors. By definition, the process seems simple. You apply for some form of debt consolidation, usually a personal loan. If approved, you consolidate all of your debt into a single financial instrument, often at a lower interest rate and with lower monthly payments. Paying off your debt suddenly becomes realistic. On top of that, you no longer have to deal with the hassle of talking to multiple creditors about your debt. Seems like a good deal on paper.
Before you get too excited about consolidating your debt, though, you should know that the scenario we sketched out above is ideal, not guaranteed. If everything works out, then that's what debt consolidation does, but plenty of different outcomes are possible.
To understand this point, first you need to understand that debt consolidation is not a solution to your debt problems in and of itself. You can use this tool to make your debt a little easier to handle, giving you some breathing room to get your financial life in order. The outcome depends on your circumstances as well as how you use this tool, not on the existence of the tool itself.
In other words, debt consolidation yields many different results based on the person who is consolidating the debt. Below, we sketched out five possible outcomes to debt consolidation, so you can get a better idea of what you might be getting into.
1. Your application for debt consolidation is denied
Your dreams of consolidating your debt and having a better financial future can end abruptly if your application for debt consolidation is denied. It happens all the time.
Usually, people face denial for debt consolidation because they have bad credit. Two of the major methods of debt consolidation, namely a debt consolidation personal loan and a balance transfer credit card, require a creditor to lend you money in order to pay off all your debts at once. Whether you're using the loan or transferring your debts to a new low-interest credit card, you're borrowing from someone in the short term to eliminate all your debts in the long term.
Creditors look at all kinds of different factors when deciding whether to lend to you, but your credit history is usually of the most interest. If your credit score is low and creditors see a history of missed debt payments, they'll be much less likely to lend to you.
If they decide you're too great a risk, they'll deny your application for debt consolidation. That will leave you back at square one.
This situation is unfortunate in many ways. After all, people generally miss their debt payments because they can't keep up, not because they just don't feel like paying their bills. By most measures, they need debt consolidation more than anyone does.
Still, if your credit is less than stellar, you'll probably struggle to lock down debt consolidation. On the bright side, many lenders specialize is offering loans to those with less-than-stellar credit. However, take note that you will likely face terms that are a little less friendly than you'd hoped.
2. You consolidate a portion of your debt, but not all of it
Just because you gained approval for debt consolidation, that doesn't mean that everything's taken care of. Often, especially with larger sums of debt, you won't be able to gain approval for a loan large enough to consolidate all of the debt at once.
Imagine you have $8,000 in outstanding credit card debt spread out across five different cards. You want to consolidate all of that debt into a single personal loan with a lower interest rate and payments that are more manageable.
You talk to some lenders and the best offer you can get is a personal loan for $5,000. You can consolidate the majority of your debt with that money, but not all of it. What do you do?
In this case, you formulate a plan. You figure out which cards are costing you the most money in interest and you pay those off first. Or, you can choose to focus on the debts with the highest minimum monthly payments. You won't consolidate all of your debt, but you'll make it much easier to deal with by moving a huge chunk of it over to friendlier personal loan.
After that, you should sit down and crunch some numbers. How much would you have to pay each month on your loan and your credit cards to pay them all off at the same time? Is it viable for your budget?
If you can afford it, there's your plan. If not, you can also look into options to consolidate the rest of your outstanding debt as well. Another personal loan might work here, as would a balance transfer credit card, which ideally should halt or slow the accrual of interest and make your debt much easier to pay off.
3. You end up scammed
If you've ever flipped through the TV channels late at night, then you've probably seen plenty of commercials advertising debt consolidation services. Usually, they feature shots of happy people while a voiceover makes promises about how the company can get you out of debt fast and guaranteed, regardless of your credit history.
If you're a perceptive consumer, this kind of poorly made advertising, coupled with the outlandish promises, probably sets off more than a few alarms. It can't possibly be that easy, can it?
For many people struggling with debt, though, these commercials can be persuasive. Maybe they've already tried debt consolidation through more obvious routes. Maybe they're in a desperate situation. They pick up the phone and call; hey, what could it hurt?
This is how consumers fall into a debt consolidation scam. It's not to say that all television advertisements are for disreputable companies; it's just that people without many options ignore the warning signs.
High monthly "service" fees but no service
Many disreputable companies in the debt consolidation space make their money off "service" fees, charging customers to retain their debt consolidation services. These fees can run a few hundred dollars per month in the extreme, which just makes things worse.
There are legitimate reasons a company might charge a service fee, though, especially if it's doing active work on your behalf. Scammers, though, charge these fees without doing much at all. What kind of service is that?
Lack of transparency or accountability
Ask yourself this: what happens if the debt consolidation company fails?
After all, most of the approach is negotiating with your creditors on your behalf. They say that they can get your debts lowered or forgiven, but there's no guarantee that your creditors will take the deal. What happens then?
Check your paperwork. Does the debt consolidation company only list a P.O. Box as an address? Is there language in the contract that prevents you from seeking reparations for lack of service? If you asked them to halt service and stop withdrawing money from your bank account, would they do it; or, would you have to close your account to stop them from bleeding you dry?
If there aren't mechanisms in place to prevent fraud, then you should be extra cautious.
Slow to deal with your debts, if at all
As human beings, we're often driven by the incentives that are in front of us. You go to work to make money. You shop around to get the best price. In short, you strive to maximize benefit by minimizing costs.
For fraudulent debt consolidation companies, the incentives are clear. They don't really have the will or the ability to actually deal with your debts, so they don't even try. They drag their feet and draw out the process.
Why? Because, for every month they stall, they collect a monthly service fee from you for doing next to nothing. To them, it's free money, and if they're relatively untraceable, they have no incentive to stop.
Our advice is to be careful with whom you choose to work. Do as much research as you can upfront, including reading unbiased reviews from past customers to get an idea of what working with this company is actually like.
4. You consolidate your debt, but fall back into bad habits
Say you avoid the pitfalls discussed above. You gain approval for debt consolidation; you manage to consolidate all of your debt at once; and you work with a helpful, professional, and reputable company to boot. All of your problems are solved now, right?
Wrong. As much as we'd like to say that you're in the clear if you get this far, we'd be lying. When it comes to debt consolidation, the biggest threat to your success is actually yourself.
Think about the reasons you fell into debt in the first place. For most, those reasons are mixed, but if you think hard enough, you'll probably find an underlying theme.
For instance, many people fall into debt due to financial emergencies that are beyond their control. Often, these pop up due to other dire circumstances. One of your family members becomes ill or injured and you have to borrow money in order to pay for treatment. You crash your car and need to get it fixed ASAP so you can keep getting to work. You're out of cash and they're about to turn off your utilities. You get the idea.
Unfortunately, many fall into debt due to irresponsible, impulsive spending. They can't stop themselves from shelling out to be the first to have the latest gadget. They're having a bad day so they treat themselves to a shopping spree and a fancy dinner out. They can't say no when their friends want to paint the town red. To make it worse, they end up offering to cover everybody's bar tab with a credit card.
While one group of scenarios is more sympathetic than the other is, they both have one thing in common. To some degree, both are avoidable.
Building up your savings account little by little can help you to avoid falling back on credit when emergencies inevitably strike. Learning a little bit of financial discipline and setting a budget for yourself can prevent you from gradually running up your credit cards. It's not always easy, but it's possible.
Why do we bring this up in the context of debt consolidation? As we've said, debt consolidation is a tool; it's not a solution for your debt. If you consolidate your debt and then fall back into these bad habits, your reprieve from debt isn't going to last long. Within a couple of years, you'll probably be overwhelmed with debt again and seeking consolidation. Except this time, your financial situation will be worse, and it will be that much harder to find effective consolidation.
5. You stick to the plan and succeed in becoming debt-free
We saved the best for last. If you can avoid the scenarios we outlined above, you stand a good chance at becoming debt-free. Consolidate your debt, avoid scams and bad habits, and dedicate yourself to getting out of debt in a reasonable amount of time. If you can do all that, your future will be bright.
If you're interested in talking to a debt consolidation partner, we'd be happy to walk you through your options. Contact National Debt Relief today for more information!