Consolidation Loan: Right or Wrong?

First let me explain what a consolidation loan is.

A consolidation loan is when you have several outstanding debts and you desire to lump them together into one new loan and begin making one (potentially) lower monthly payment. The motivation is usually to simplify your monthly payments and hopefully lower the overall interest rate.

For example let’s say you have the following debt obligations:


Interest Rate
Monthly Payment
Years to Pay
Total Cost
Gas Card
Dept Store


You are burned out writing seven checks each month and you are beginning to fall behind on several of the payments. The stress is building and you are looking for solutions.

Now let’s say you are offered a consolidation loan at 12% with monthly payments of $254 for 10 years. In this case, you would be paying $30,480 in total cost ($254 x 12 months x 10 years) This is practically the same thing if you were to keep your original loans and not consolidate, but you are extending the number of years you would be paying. The lower interest rate combined with a longer term makes the total cost about the same. In many cases, the consolidation loan might end up even costing more than if you kept the original loans.

You might be thinking, I can lower my monthly payments by $163.00 per month. Why wouldn’t I want to do it?

Don't always make your financial decisions by looking at how much the monthly payment is going to be. There are more important issues to be looking at:

1. Have you solved the spending problem that put you in this position? In other words, if you obtain this new consolidation loan, what is the potential for you to max out the credit cards again?

2. Have you been able to control your overspending for at least 6 months. The best way to determine this is by evaluating your credit card balances. Has the trend been up or down? If the trend is up, consolidation is not your best option.

The best plan

No matter if you keep the original loans or obtain a consolidation loan, be sure that you never decrease your monthly payment amount until the debt is paid in full. For example, if your present monthly obligation is $417 per month, never decrease this amount. When you pay off one card, allocate the amount you were paying on that card, to another card. This will help you accelerate your debt reduction. For example, if you were paying $50 towards Visa and now the credit card account is paid in full, begin to add $50 more toward your Master Card account, or any other account.

In the illustration above, if you continued paying a total of $417 every month, you could be out of debt in about five years! If you gradually decrease your payments every month (when one loan is paid in full), it could take over eight to ten years to pay them off. Keep your monthly commitment to reduce your debt at $417 or MORE each month!

A different perspective . . .

I know this might be hard to believe, but in some cases it is better to keep high interest rate credit cards and pay them off, than to obtain a lower interest rate consolidation loan.

Here is the reason why. You will be better off keeping the higher interest rate credit cards and slowly pay them off -- than to transfer the balances to a lower consolidation loan and eventually max out the credit cards again.

For example, if the credit cards are maxed out and you cannot charge any more, this is all the debt you have! But, when you zero the credit card balances out, obtain a new loan, and eventually max out the cards again, you have doubled your debt and doubled your financial trouble!

Keep things in perspective. Sometimes several loans at 18% are actually financially better for you than one new loan at 12% -- if you have not learned to control your spending! Consolidation loans can work and save you money, but only if the spending problem has been solved!

 © copyright - 2000, Ethan Pope