Why You May or May Not Want to Consolidate Your Loans

USA Today talks about college students consolidating their student loans, but their list can be applied to anyone who has loads of debt and wants to have them all consolidated with one lender. They suggest the following as reasons to consider loan consolidation:

• You still have variable-rate loans.
• Lower payments.
• Fewer bills to pay.
• Borrower benefits.

They are correct -- these are benefits of loan consolidation. If you are someone who accumulated tons of debt and now has your finances under control, debt consolidation can be something you'll want to seriously consider. But in most of the cases I've dealt with, loan consolidation is used incorrectly and leads to people becoming mired in additional debt. It goes something like this:

1. Jim spends like crazy racking up tons of debt -- much of it credit card debt.

2. Jim's debt gets to the point where he can't manage it. He simply owes too much and at too high of a rate. It's putting a lot of pressure on him and his finances.

3. Jim consolidates his loans. He usually gets a lower rate than what he was paying and he extends the payments over more years. This allows him to make a much lower monthly payment, taking pressure off his finances and freeing up some cash every month.

4. He goes back to his free-spending ways, racking up more debt (again, much of it is on credit cards.)

5. He eventually gets back to the point he was in in #2 above. Only this time, no one will consolidate his loan -- he's simply got too much debt and is too risky. Now he's stuck, and he's in big financial trouble.

So let me say it again: If you are someone who accumulated tons of debt and now has your finances under control, debt consolidation can be something you'll want to seriously consider. But if you don't have your finances (your spending, really) under control, then I recommend you do NOT opt for a loan consolidation. It won't help you in the long run and eventually you'll end up in worse shape than you are now.

Comments

[TheJapChap]

Spot on... As a loan officer who deals with this on a daily basis, I am amazed to see the number of individuals who consolidate to create some breathing room--only to spend this "savings" into obilivion. If irresponsible spending habits are the root of the problem, consolidation alone will do very little to fix them.

[Stephanie]

Of course, with student loans, you have to be careful...once you consolidate your loans, you can't "reconsolidate" with a lower rate unless you have more loans to include.
Almost immediately after graduation, I consolidated my government loans with the company that I have my private student loans with. I'm not sure if it was the best thing to do, except that it helped me keep track of those loans more easily. Part of me also wishes I had shopped around a little bit to see if I could have gotten a lower interest rate.

[Dividends4Life]

The focus should always be on eliminating debt. As noted, consolidation often leads to expanding debt.

Best Wishes,
D4L

[wealthy_1]

Are you sure you weren't talking about me? I was feeling a little deja vu. That certainly was me. Several years ago my husband and I consolidated our credit card debt and paid it off through a 401K loan. Then he lost his job. That loan became income and we had a HUGE tax bill the following year. The IRS was nice about a loan to repay it. But as soon as we sold a piece of property we had, we paid that loan off. As you can see, we were in an awfully vicious cycle.

Happy holidays and thanks for reminding me why I am now on a cash basis for purchases!

[PoorBrian]

Yep, been there and done that! My wife and I consolidated our debt (credit card of course!) and two years later we're back in the same spot. The first time we got scared but we didn't learn that we had to change OUR habits. No one was going to wave a magic wand and solve our problems. We are the only ones that can solve our problems. Now we are on track to paying off our debt, both the consolidation loan and all the new credit card debt!