Individuals considering debt relief often ask “When does debt consolidation go wrong?” People who are burdened with multiple debts often resort to getting a debt consolidation loan to solve their financial struggles. This approach is believed to give you relief since you’ll merge your debts into a single manageable payment, and it can lower the interest rate you have to pay.
Debt consolidation really sounds good to the ears. However, it isn’t a magic bullet that can solve all your debt problems. Of course, there are still steps that you have to make to get out of debt. If you don’t take extra precautions when taking out a debt consolidation loan, your financial situation might get worse.
For you to be on the right track when opting for a debt consolidation loan, you must learn the common mistakes that people make when consolidating their debts.
When Does Debt Consolidation Go Wrong? – The Play By Play
Not Having a Full Grasp of Your Financial Situation
Debt consolidation can be an excellent way to ease your debt problems. Consolidating multiple debts into one will give you freedom from the grip of multiple creditors because you’ll now be making fixed payments to one lender. It can also help you keep track of your financial obligation well.
However, if you don’t understand how you get into this tough situation of having too much debt, there’s a chance that you won’t change your spending habits even after taking out a debt consolidation loan.
Typically, individuals who choose this approach are consolidating at least tens of thousands of dollars (say around $10,000 to $15,000). They don’t notice at first that they’re accumulating too much debt, and when it balloons to the point that they find it difficult to repay, they apply for a debt consolidation loan.
So, you need to diagnose the problem first before deciding to consolidate your debts. Ask yourself how difficult your situation is and how did you get to this point in the first place. It’s a time for reflection and being honest with yourself.
Let’s say you’ve consolidated your debt: are you sure that you can repay your new loan and prevent yourself from getting into a debt trap again?
Take a look at your bills, credit card statements, and receipts to have a clear evaluation of your spending habits. Know the factors that led you to have a mountain of debt and ensure that you’ll curb your impulse buying next time. Learn how to save money so that you can buy what you need and want without resorting to borrowing money.
Failing to Limit Your Use of Credit
You’re in the wrong place if you don’t know how to limit your use of credit after taking out a debt consolidation loan. Yes, you can save money if you consolidate your credit card debts into another loan or a card. However, you may resort to using your credit cards again if you spend too much.
Take the smart route by learning personal finance and limiting your access to your credit cards. In this way, you can resist the urge to splurge. If you have cards that you don’t need, it will be wise to close them or put them somewhere beyond your reach to discipline yourself.
But keep in mind that closing your credit cards can have a negative impact on your credit history. Nevertheless, you must sacrifice credit scores for this period of time to enjoy a debt-free life in the long term.
You can also keep one credit card open to minimize your chances of getting a bad credit score. For instance, choose a card with the longest and best credit history. If there are unexpected expenses or emergencies, for instance, you can use this credit card to cover the costs.
Not Considering All Options
You have several options when consolidating debts. The most popular one is getting a secured or unsecured loan at a bank or credit union. In this case, you might need a personal loan to pay off debt.
You can also use the equity of your house as security for the debt consolidation loan to avail of a lower interest rate. Lastly, you can go for a balance transfer, which moves your debts into a single card.
There’s also a consumer proposal, a form of insolvency that consolidates and decreases your debts. But it’s better to consider this one as a last resort. Another option that you can take is a debt management program, which combines your unsecured debts into an affordable single payment.
No Concrete Plan for Repaying Your Debt Consolidation Loan
It can take you several years to pay off your debt consolidation loan, especially if you only pay a minimum payment each month. Of course, it’s not an easy path to take to become free from debt. And if you take on another debt then another during this time, you will exacerbate your already bad financial situation.
Typically, debt consolidation loans have a set deadline. There are credit counsellors that help you create a repayment plan to pay off your debt, and the term can last up to 3 to 5 years. If you choose a balance transfer or a line of credit, you can set your debt repayment plan on your own.
Make sure that your repayment plan suits your monthly income. In this way, you won’t find it hard to pay your debt off and cover your day-to-day expenses at the same time. It’s a matter of allocating your resources well to your financial obligations. In fact, you can use a cash gift or tax refund to pay your debt consolidation loan.
Debt Consolidation Can Be Expensive if You Extend It
Choosing a longer loan term for your debt consolidation loan can lower the amount you pay every month. The catch is that you’ll pay a higher interest rate that is spread out during the period of your loan payment.
You must avoid paying higher interest rates for your debt consolidation loan, and you can do this by choosing a shorter repayment term. But you should make sure that the loan term you pick fits your financial situation.
Debt consolidation can be an ideal option if you want to combine your debts into a single payment with an affordable interest rate. But if you don’t take the necessary precautions, anything can get wrong when consolidating your debts.
So, you should understand how debt consolidation works and get advice from debt management experts at debt.ca.