Many people talk about debt consolidation as a solution to their debt problems.
However, most of the time it is an empty promise that, by not solving the root cause, ends up generating more problems.
WHAT IS DEBT CONSOLIDATION?
The consolidation of debts implies, in some way, to take a loan and with the amount of this, to liquidate all the others that we have in force. That is: we change all our debts by one.
For this to make sense, the new debt should have a significantly lower interest rate than the loans we had. And of course: the amount we have to pay each month should also be much lower, so that we can be a bit less tight in our cash flow.
The problem is that this rarely happens. If we are indebted to the neck, as it is commonly said, it is very difficult to obtain a loan that is sufficient to be able to pay all the other debts that we have. But in addition, in case we can get it, it is very unlikely to be at a lower interest rate, since we represent a risk to the institution that gives us the money.
Finally, the new debt that we have acquired has to be a long term so that it can actually imply a lower monthly payment than we had before doing the debt consolidation.
WHY IS DEBT CONSOLIDATION NOT THE SOLUTION?
People who have a severe debt problem usually bought it because for several months – or years – they have become accustomed to spending more than they earn. That is, the money they receive is not enough for them to live, and therefore they have to use credit to get ahead.
Debt consolidation does not solve this – it’s simply changing several loans by one. The underlying problem, the reason we fall into a severe problem of indebtedness, is still there. And this can be very dangerous.
I have seen several cases of people who managed to consolidate their debts but continued to use their credit cards: those who paid with the amount of the new loan they obtained to make the consolidation.
Then, they are left with a great debt – the consolidated one – but they begin to acquire others derived from the use – again – of their credit cards.
Many readers might think this is very innocent and very little happens. For I have seen it: it happens much more often than you imagine. The reason is very simple and we have already commented: people are already accustomed to spend more than they earn. They usually can not meet their needs – and the payment of consolidated debt – with the income they have.
Then, they are forced to take back their credit cards, which causes their problem to grow and again get out of control. There is even a very close case of friends who consolidated their debts through a liquidity mortgage. But they went back to using their credit cards and little by little they were falling into a huge problem. Now they have a high risk of losing their home: they are struggling a lot to continue paying that mortgage.
There are occasions, however, in which debt consolidation can make sense. Of this I will speak in the following post.
WHAT DO YOU CONSIDER OF DEBT CONSOLIDATION?