Is Debt Consolidation Bad? 7 Traps to Avoid

When you're overwhelmed with the heavy weight of debt, you may start to consider consolidating your loans into a single payment. The idea of making one payment per month to pay down all your loans is a good one — but is it too good to be true?

Debt consolidation isn't a magic fix for your financial situation and there are a few traps you'll want to avoid while going through the process. But that doesn't mean debt consolidation is bad. In fact, it can really help improve your finances if you do it the right way.

If you make payments on time and stick to a repayment plan, you can eventually get out of debt and improve your credit. Before you get there, though, watch out for some of the debt consolidation traps to avoid along the way.

Repeat after me, consolidating debt does not erase your debt. You still have to pay it after it's consolidated. You might be able to get a better interest rate — which can save you some money in the long run — but you'll still be on the hook for paying it off.

How to avoid it: Be sure that you fully understand the terms of your consolidation. Your payments may be higher each month, so knowing you can afford to consolidate is key. 

Set reminders, or if you're financially able to do so, set up automatic payments, so your payments are always on time.

Think that consolidating debt means putting all of your debt together no matter the amount, length of repayment, and interest rate is a very common misunderstanding. There are specific types of debt that should be left alone and not thrown into debt consolidation.

As a general rule, avoid consolidating any debt that will experience an increase in interest rate simply because you consolidate it. With a higher interest rate, you'll end up paying more money on the debt than you would've had you kept it separate at a lower interest rate.

For example, let's say you have one debt of $1,000 with an interest rate of 10% over 5 years, and another debt of $5,000 with an interest rate of 20% over 3 years. If you were to consolidate both of them with a new interest rate of 15% and repayment period of 5 years, you'd actually end up paying an additional $600 in interest.

How to avoid it: Grab your calculator and do the math. If it turns out that you'll pay more, consider other options or leave out some debts when you consolidate. 

Remember, just because you can consolidate the debt, doesn't mean you have to or should — choosing the option with the lowest interest is likely your best bet.

Do you buy the first pair of shoes you try on at the store? Probably not, but if you do, ditch your shoe shopping habits when looking for help with options for debt consolidation.

To keep with the shoe analogy, there are several options for consolidating loans, just like there are several types of shoes to choose from. Some debt professionals will support and guide you through your options, helping ensure you're making a good financial decision. Others might lack quality customer service or not advise you at all on making an informed decision.

How to avoid it: Do your research and get help from a reputable company. If you have friends who have consolidated debt, ask about their experience. 

Read up on different professional agencies that specialize in debt consolidation. Also, ask what you may qualify for at more than one place so you can choose the one that fits your needs best.

Most everyone knows that agreeing to pay a higher interest rate isn't ideal, but it does occasionally happen — especially if you're misinformed or don't read the details of your agreement.

If your interest rate is high, find out why before moving forward. For example, if it's due to your credit score, you might decide to postpone debt consolidation in order to improve your credit score to qualify for better interest rates.

How to avoid it: Make a list of all your debt and corresponding interest rates, so you know exactly what you're dealing with. This will prevent you from blindly accepting a higher rate and help you decide which form of debt consolidation may be right for you.

Figuring out how to pay off debt is equally as important as asking yourself how you got into debt in the first place. Consolidation could be the stepping stone you need to successfully climb out of debt, but without a grasp on the root cause of your money troubles, you could find yourself right back where you started shortly after.

How to avoid it: Analyze exactly where your money is going and figure out where you can cut back on expenses. The golden rule of not spending more than you earn is priceless here. 

If you aren't sure where to begin or are afraid of facing your debt, consider reaching out to a financial professional for advice.

After you've consolidated your debt and the balance on your credit cards is zero, you may feel like you have a free pass to start racking up more debt. Avoid this at all costs! Having a zero balance doesn't mean you have zero debt, it just means you've consolidated it and can begin paying it off in a single payment, instead of managing several payments simultaneously.

Using your credit cards too quickly after consolidating debt is a quick way to worsen your financial situation. You'll have even more payments to keep up and it could absolutely tank your credit score.

How to avoid it: Create a budget you can stick to, that doesn't involve using your credit cards. You may decide you don't need to close them, but avoid using them for a good long while once you consolidate. 

While keep your accounts open can help continue the aging of your accounts, if it's too risky to keep them open (i.e. if you can't trust yourself not to use them), it's probably best to cut them up.

After you've consolidated your debt and are ready to move forward, don't forget to put a plan in place that can help maintain financial wellness and stability in your future. 

Debt consolidation is just one part of the plan, but identifying a well-rounded path is key for a healthy financial future. Without it, you could run the risk of mishandling your money again in the future and landing back in debt.

How to avoid it: Write down a plan to the best of your ability on how you want things to be moving forward. Stay open to the idea that the plan can change. 

Create a budget you can stick to that includes all your monthly payments, savings, and other necessities, like food and gas. If you can, build an emergency fund so you won't have to rely on credit in the future should an unexpected expense arise.