Disadvantage of Debt Consolidation - The Facts About Debt Consolidation

You will have no problem at all finding thousands of pages on the internet extolling the virtues of debt consolidation, but that is because they are all by people who are selling it as a service and therefore have a vested interest in pointing out the positive side. Getting to know what the possible disadvantage of debt consolidation can be is an altogether more difficult business, which is where this article comes in.

The first thing to say is that there is more than one type of debt consolidation, and the disadvantages are different with each one, so we will consider them separately. One form of consolidation is to take out a new loan in order to pay off all your debts. These are known as debt consolidation loans. The other way to consolidate debts is by using a debt management plan.

When you take out a new loan to pay off your debts, you are already at a disadvantage, because the very idea of taking on new debt is a risky strategy. Using a loan will certainly consolidate your debts, because you only have one single payment to think about, but it is very easy to end up worse off if you are not very careful.

Many people take the advice of the potential lender at face value and look at the single smaller monthly payment as an indication that they will be better off. A lower monthly payment does not necessarily mean that a new loan is going to cost you less than your old debts. The reason most payments for consolidation loans are lower is that the loan is for a much longer period than your other debts were. In many cases if you add up the total that you will have paid by the time your new loan is paid back you will find that it has cost you far more than your old debts would have.

There is another disadvantage of debt consolidation with a loan if you are not very careful about which debts you consolidate. A lender will want you to include all your current debts and take out a loan big enough to pay off everything you currently owe. That can be tempting because the simplicity of a single payment is one of the attractions of debt consolidation, but you need to be very careful or you can end up costing yourself more.

What frequently happens is that people include all their debts, some of which may actually be at very low rates of interest. If you do not check whether the new loan is at a lower rate than the debts you are paying off, you may in effect be swapping some of your debts for more expensive ones. Before agreeing which debts to consolidate you should list out all your debts with the corresponding interest rates that you are currently paying. Check the interest rate for the new consolidation loan and only include in it those debts that are at a higher rate of interest.

There are so many disadvantages with debt consolidation through a loan that the vast majority of situations are better dealt with through a debt management plan (DMP). In case you are not aware of how a DMP works, an experienced debt advisor negotiates with all your creditors and tries to set up new arrangements for paying back your debts. The idea is to reduce the amount you have to pay out each month by getting reductions in interest rates and other charges, which often includes writing off any penalty fees or extra charges.

When these negotiations are complete, you just make one single payment to the debt company and they have to deal with your creditors for you. You immediately avoid the big disadvantage of a debt consolidation loan, as there is no new borrowing involved, and the debt company often provide additional free services such as help with budget planning and tips for spending less.

A disadvantage of debt consolidation through a DMP is that they are only informal agreements, so you cannot force any creditor to participate if they do not want to. While many see this informality as a positive aspect of debt management, because it means you can change or get out of the agreement if your circumstances should alter, it does have a negative side too. There is no formal protection with a DMP, so if a creditor decides they want to take you to court instead, there is nothing in the debt consolidation process that can stop them.

The other disadvantage of debt consolidation through a DMP is that there are fees involved. All debt management companies have to charge for their services, and these are usually built into the payments you make. You could arguably save on these if you undertook the negotiation process yourself, but most people would not feel capable of doing that and in any event you would lose part of the benefit in not having to deal with all your different creditors payments.

The most important aspect of debt consolidation is to get reliable advice from a reputable company, so that you are advised properly on which route is going to work best for you. It is easy to apply quickly to several companies and compare the proposals and recommendations that come back. Start with a list of recommended companies that have a proven track record.