Consumer debt has reached record highs in the United States over the past generation. While previous generations valued savings, the United States has become a consumer society valuing instant gratification over sound financial planning. If it sounds as if I am speaking from experience, I am.
One consequence of this phenomenon is that debt consolidation has become increasingly popular over nearly all sectors of society, particularly the middle class. “Debt consolidation” simply means taking out a single loan to pay off all of your existing debts. This loan may be a bank loan, a second mortgage, a credit card, or any other type of loan. This procedure simplifies repayment, but more importantly it can save the debtor a lot of money if the loan is extended at an interest rate that is lower than the average interest rate of the debtor’s current loans.
Opinions are divided on the wisdom of debt consolidation. Some commentators note that the motivation for a debt consolidation loan is simply to allow the debtor to continue spending and borrowing, often leaving the debtor in a worse position that before consolidation. More prudent debtors, however, will use their interest savings to pay off their debts, thus lowering their debt burden while at the same time improving their credit rating. Accordingly, the opinion of this author as to the wisdom of debt consolidation comes down to a simple question: Why are you doing it?
Before taking out a debt consiolidation loan, consider the following:
1. Will the proposed debt consolidation loan allow you to pay significantly lower interest? Do the math and come up with a number. How much money will you be saving?
2. What will you do with the money? At least some of it (preferably all of it) should be earmarked to pay off the debt for which the loan has been taken out.
3. What will you do once your debt burden decreases and your credit improves? Avoidance of debt is like losing weight – quick fixes don’t work; permanent lifestyle changes are required.