Most credit active consumers think the best way to settle debt is by taking out a consolidation loan. But consolidation loans do not settle debt, they merely group up your debt obligations into one new loan amount stated debt counselling specialists, DebtBusters.

Like with most things in life there are pros and cons. “The goal of a consolidation loan is to reduce monthly instalments usually by means of lower interest rates and extended payment terms. If this sounds like a solution that could work for you, it will be worth your while to look a little deeper into the advantages and disadvantages of a consolidation loan,” DebtBusters added.

Pros and Cons of debt consolidation

The obvious benefit is one monthly repayment with one interest amount as opposed to paying varying interest rates across multiple debt obligations. When you take out a consolidation loan, the amount borrowed is used to settle your old debt obligations, leaving only the consolidation loan for you to repay each month.

“A consolidation loan pays multiple old loans with another bigger new loan. You are essentially paying old debt with new debt,” DebtBusters explained.

But if you’re thinking that this could be a quick fix to all your money troubles, you may want to think again.

Below are some of the cons to debt consolidation that DebtBusters has identified:

  • Although you might save in the short term because of reduced interest rates, consolidation loans normally stretch over longer periods of time so you might end up paying more towards your debt in the long term.
  • Consolidating your debt can potentially open doors for more poor spending habits. Paying off your debt can give you a false sense of financial freedom, but those credit cards or over drafts will still be available to use and this might cause you to fall into a worse debt situation.
  • Your debts do not reduce when you consolidate them, you only replace one or many debts with another one. Which will not be a good idea for over-indebted consumers.

The bottom line is that while debt consolidation might be a good option for consumers who are not over-indebted and want to make payments more manageable, it is not always the best or only solution.

So what are the alternatives?

“The main one is the process of debt review. This process takes into account all of the consumers’ debt and it establishes an affordable payment structure to get the consumer out of debt, rather than simply one loan,” DebtBusters highlighted.

The need to have to look into options like debt consolidation and the debt review process should not be there if you learn to better manage your money.

But if you find yourself in the position where you are considering applying for debt consolidation, the best advice would be to make sure you are realistic about what it can do for you.

Until next time,
The MoneyShop.co.za Team