Debt can accumulate on a variety of financial instruments, including credit cards, overdrafts, personal loans, and mortgages. Not all debt is bad, provided that you can comfortably stay on top of it and have a plan for repaying it. For example, most of us require a mortgage at some point in our lives to enable us to end up owning our own home. However, for many, debt can become something that just keeps on mounting and ends up crippling our finances and causing all manner of emotional stress.
Debt consolidation is a term that you may have heard of, as a means of bringing debt under control. How does it work though? Well, let’s imagine that you have $5,000 on credit cards (charged at 13%), $2,000 on an unauthorised overdraft (charged at 25% and incurring fees) and $3,000 on a personal loan (charged at 5%). It’s easy to see from this example that the credit card and overdraft debt are very expensive and you may have reached a position where you can no longer afford to even service the interest (and charges) that you are incurring, never mind have any hope of paying back the capital amount.
How debt consolidation works is that you would approach your lender and ask that your credit card, overdraft and loan debt be rolled into one loan. So, in my quoted example, you might end up with $10,000 on a loan, charged at an interest rate of 5%. You still have the same amount of debt but your monthly interest payments will be significantly reduced. This can create some breathing space to allow you to regain control of your finances.
The main benefit of debt consolidation is that you reduce the interest payments. However, set against this, the main downside is that loans require a set payment to be made every month and such payments are usually automated via means of a direct debit. So, for example, on the 25th of each month a payment for a set amount will come off your checking account. Credit cards and overdrafts offer more flexibility in terms of repayment. Personally speaking, however, if your finances have reached a dire situation, you will be much better with the regimented loan repayment mechanism rather than paying the extra interest on credit cards and overdrafts, both of which are particularly dangerous forms of credit precisely because they offer the borrower the opt out’ of saying I won’t pay the full amount back this month’!
If you are unsure whether to go down the debt consolidation route, then it may be worth speaking to a financial adviser or to another organisation (such as a Citizens Advice Bureau) for advice and guidance. Also, if you believe that you have the ability to pay off your debt without requiring debt consolidation, then at least make sure that you begin by targeting the most expensive forms of your debt, namely your unauthorised overdraft and your credit cards.