Loan Consolidation: Does It Make Sense?

March 31, 2007 By Matthew Paulson

American households are finding themselves with major financial problems more and more these days as the amount of available consumer credit keeps going up, and advertisements for such products is everywhere. The credit card industry alone sent out over 6,000,000,000,000 offers for new credit cards last year alone. Many people keep borrowing and borrowing without thinking anything of it, and then find themselves in a financial mess. They then see advertisements for loan consolidation services which offer to move all of their high interest debt into a debt consolidation loan at one lower interest rate. Is this a good way to solve your money woes and burdening debt problems? Let’s find out.

Loan consolidation essentially takes all of your consumer debt, such as car notes, credit card debts, personal loans, unpaid bills, and the like and pays it off. You are then given a loan for the amount of money that was used to pay off your existing debts. If you have a lot of high-interest debts, chance are your consolidated loan will have a lower interest rate. It certainly would make mathematical sense to do a loan consolidation.

We have to remember that there are two words in personal finance. The finance part is the mathematics. The person part is your behavior. It makes sense to go do a loan consolidation, pay one simple payment, and get a lower interest rate, but for this to work, you also have to stop the behaviors which got you into a financial mess in the first place. You need to quit spending too much money and borrowing up to your eyeballs. You need to change your behavior for this to work.

Quite often people get into a loan consolidation program, often called a debt consolidation program, only to get themselves back into huge amounts of debt. The problem is that they never changed their behavior. Most people have a tendency to borrow money when they can’t afford something, and think little of it. After they get their consolidation loan, those behaviors don’t change. And now since all of their credit cards are paid off, they charge a bunch of money back up on them and get themselves in a deeper hole.

Many financial counselors, such as Dave Ramsey, don’t recommend debt consolidation for exactly this reason. They rightfully argue that your behavior is much more important than this one action. You need to systematically pay down your debts and learn to live on less than you make, and just entering into a loan consolidation program to take care of your money problems won’t do it.

At the end of the day, it makes sense to enter into a debt consolidation program if you have a lot of high interest debt that you can’t pay, but you can only enter into one if you change your behavior. You have to stop what you were doing that caused you to get into the loan consolidation program in the first place. Live on less than you make, save money for the future, and systematically pay down your debts.

Posted in debt

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