Should You Use a Debt Consolidation Service?
I am sure you have seen or heard many advertisements on credit consolidation and the thought might have crossed your mind: “Should I call them?” After all, your debt is increasing every day and things don’t seem to be improving any time soon. So, is debt consolidation the way to go?
There are benefits to using one of these services to assist you. For example, these services can:
- Reduce some of the stress by combining all your debt to one payment a month;
- Lower the interest rate on your current credit card accounts dramatically;
- Improve your cash flow by lowering your overall payments for each month;
- Eliminate late fees and penalties;
- Improve your credit score.
But keep in mind that it is not as great as it sounds, there are other factors that you should consider before you decide to use a debt consolidation service or not:
The debt doesn’t just go away!
Your debt is just consolidated into one pretty package. So whether you are paying one payment or 3 or 4, the amount you owe is the amount you owe. Unless the company is able to help you reduce your total debt, the amount you owe is there until it gets paid off.
A lower interest rate doesn’t mean you pay less interest
The debt consolidation companies are often able to reduce the interest rates on your current credit card accounts. You might be currently paying a 24% or even a 29% interest rate and they might be able to reduce it to 10% or even less. But if they have reduced your monthly payments and interest rates at the same time, then most likely you will be paying your debt for many years to come. If you were required to pay off your debt in 5 years before, now you might be paying it off in 15 or 20 years. More years to pay means more interest to pay. Here’s an illustration:
Let’s say you have $10,000 in debt with 24% interest rate and you pay $300 a month for less than 5 years. You will be paying a total of $6,060 in interest rates.
Now if you had the same debt of $10,000 with 10% interest rate you can pay as low as $120 a month for almost 12 years you will be paying a total of $6,875.
So as you can see, you will have a lower monthly payment and lower interest rate, but at the end of the 15 years you will have paid more in interest.
Of course the main factor is how much can you pay on a monthly basis. If you can increase your monthly payment from $120 to $150, it would have a major impact on the total interest you will be paying as well as how fast you can pay it off.
But don’t forget, you can also pick up the phone and talk to the credit card companies yourself. Let them know your situation and that you are not able to meet your debt obligations with the current high interest rates and that you are thinking about going through a debt consolidation agency. In many cases the credit card companies are able to reduce the interest rates for you directly.
False sense that things are fine
I am a big believer of fixing things at the root of the problem. If you find a quick fix to your accumulated debt, you aren’t looking at the underlying patterns that you have created in your life. The reason you are in debt is because you have lost control of your spending or your income is not matching your expenses. The more you can work on understanding how you got here, the better it is for you to learn to have a healthier relationship with your wallet. There was a bankruptcy repeat filings study done by John Golmant and Tom Ulrich for the Administrative Office of the U.S. Court where they analyzed 13 million bankruptcy filings. They found that 16% of the U.S. bankruptcy filings between 1993 to 2002 were repeat filings. In another study of Household Borrowing after Personal Bankruptcy, of those who had filed for bankruptcy, 89% had accumulated debt again and 16% had 60+ days delinquencies.
What these studies tell me is that even if one files for bankruptcy and clears away debt, studies shows that people still tend to go back to their old patterns of getting into debt… until they learn not to.
Learning the reasons behind your spending habits and debt accumulation patterns is the best way to ensure it won’t happen again.
Keep in mind the cost of debt consolidation
When analyzing all the plus and minuses of going through a debt consolidation agency, keep in mind that there is a fee for their services. Find out how much they charge; is it a flat up front fee or a monthly charge added to your payment plan? Knowing what the fees are will help you evaluate the cost / benefit ratio. Go back to the list above for all the benefits and the shortfalls of going with a debt consolidation service. Is the fee they are charging you worth it or not?
Sometimes the easy way might actually not be the best way. By learning how to deal with credit card companies, paying off your debt and improve your credit score yourself, you can build your self esteem. You can pay someone to fix the problem today or you can learn to for the rest of your life.
Have fun learning and let me know if I can help!
Comments