Problems of Debt Consolidation
There are some advantages to consolidating your debts into one consolidation loan. Even the word ‘consolidation’ is reassuring for many people. It invokes the idea of reducing a lot of little and some not so little problems into one single manageable problem. Instead of having a large number of creditors to deal with, the debtor will have just one creditor to manage and just one monthly payment to make instead of having to make multiple payments to a variety of creditors for varying amounts. As a result the debtor expects that managing finances will become simplified. The other big expectation is that the debtor’s credit rating will improve dramatically once all unsecured debts and in particular credit card debts are lumped into the consolidation. Each and every one of the old credit card accounts gets paid off once and for all. To crown it all, the monthly repayment on the consolidation loan will hopefully be significantly lower than the total sum of the repayments on all of the old debts – credit cards, overdrafts and personal loans.
Well, that is the theory anyhow. The first thing to understand is the reason why monthly payments go down at all. It is not really the benevolence or generosity of the new consolidation loan provider which prompts this reduction. There are often several factors at play. One factor is that the term of the consolidation loan may be (much) longer than the terms of the original loans. For example, had the debtor continued financing each of the old loans (instead of lumping them all into a consolidation loan), then he or she might well have paid some of them off rather quickly and others over a longer period of time. A second factor is that the lender of the consolidation loan may seek to secure the advance on the debtor’s property, often the family home. If this is the case, the lender has significantly reduced the lending risk that the debtor will default on payments since the lender may ultimately rely on the equity in the property to satisfy the debt if necessary. Lower monthly repayments are usually based on one or both of these factors. While the interest rate on the proposed consolidation loan may be lower that the rate the debtor is currently paying on some accounts at present, the total amount repayable over the full term of the consolidation loan could be considerably greater that the total now payable under the old loans.
Let’s see what things can go wrong if you take out a consolidation loan. If you are unable to make your monthly payments currently you must ensure that you can comfortably make the consolidation loan payments in a sustainable way and for the total duration of the projected term. It’s important to discontinue using the lines of credit that you have been employing. For example, it is best to cut up your credit cards since the finance companies may, now that you’ve cleared the balances, tempt you to continue to use the same credit cards that got you into difficulty first and foremost. Furthermore you will have to discontinue utilising any overdraft account facilities which unfortunately contributed to your financial difficulties to begin with. As most of your disposable income will surely have to go to repay the consolidation loan you will need to cap your access to other credit regardless of whether your ‘old’ creditors might choose to do further business with you and make various ‘attractive’ funding offers to you. It’s always best to withstand such promotions, if you want to avoid struggling financially again.
Another pitfall is that if you have agreed to secure the loan consolidation on your house and find that you are not able to maintain the repayments, you may perhaps lose your dwelling. Although you may achieve a low interest rate on the debt consolidation loan by agreeing to secure it on your home, the likely more lengthy duration of the consolidation loan will mean that you give up some flexibility relating to your mortgage loan e.g. you will not be mortgage-free as soon as you anticipated to be and you may be unable to stop working as early as you had planned to do.
Therefore, do consider long and hard before you decide to plump for debt consolidation loans. Take into consideration other options which might be appropriate for your personal situation. For example you should check whether you could be insolvent. If you really are insolvent, a couple of the options you might want to consider are either to enter into an Individual Voluntary Arrangement (IVA) or to petition for your own Bankruptcy (BCY). Those are two personal insolvency proceedings that shield you from your creditors and that also are supported by the full weight of the law behind them. Even if you’re not insolvent, you might want to consider going into a Debt Management Plan (DMP) with your creditors. You can do this yourself by gaining agreement with all of your creditors individually in regards to how you will pay back your debts to them. This is sometimes known as a self administered DMP. Most DMPs however are managed with the assistance of companies which specialise in putting together DMPs between consumers and their lenders and which then manage these plans over a period of years. Whatever you decide on, do take advice. Refrain from debt consolidation until you know about and have considered all other remedies.
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