If you are reading this, there’s a big chance that you are stressed over your debt and you are exploring debt consolidation as a way to finally get out of the woods.
In debt consolidation, you are combining your debts into one payment to make it easier for you to repay.
In some cases, you may qualify for lower interest and more flexible terms so you can pay off your debt faster.
That sounds like a no-brainer, right?
While consolidating your debt can be a wise move, it also comes with risks.
And before you sign up for a debt consolidation loan, you should be aware of the following dangerous mistakes:
1. Failing to address the cause of your financial hardship
Consolidating your debt can help you ease your financial difficulties. However, it may not be sufficient to keep you out of a dire situation.
You should tackle the root cause of your problem to avoid the trap of recurring debt.
One common cause of debt is bad budgeting habits. Without addressing this fundamental element of personal finance, you’ll just end up back in the pit.
In some cases, debt consolidation may even worsen a typical cause of debt: credit card abuse.
When you consolidate credit card debt, you can move your current payables from your cards, which makes them available again.
If you can’t develop the discipline in using your credit card, you might just circle back.
It’s best to build your budget based on your income, expenditures, savings and repayments.
Stay away from any non-essential purchases as you work towards paying off your debt.
2. Dashing into a debt consolidation loan
Amassing debt is rarely a happy experience, and it makes sense to get out of the situation as fast as you can.
However, rushing into the process can be costly.
If time still permits, you can choose to first fix your credit score before you apply for debt consolidation.
You may qualify for lower interest rates if your credit score is high. So try to look for ways to build your credit score before you look for debt consolidation providers.
Review your credit report, ideally with a professional, so you can identify quick fixes such as disputing an error or making sure that your debts are paid on schedule.
These small fixes can have huge impact on your score, which will then impact your interest rate when you consolidate, saving you more money in the long term.
3. Signing up for the wrong consolidation plan
You may still qualify for debt consolidation even if you have low credit score.
However, just because a debt consolidation loan provider offers you a loan doesn’t mean you don’t have any choice but to take it.
Choose a loan that has a lower rate per annum compared to the average rate of your outstanding debts.
Also, take a closer look at the repayment plan. While you may be attracted to lower monthly payments, it also means long-term.
Check if you can distribute the loan into a three or four-year term and what other financial goals you can defer until you pay all your debt.
4. Ignoring other options for debt settlement
Bear in mind that debt consolidation is just one strategy available to pay off your loans.
Depending on your personal circumstances and financial standing, you might be better off selecting other schemes.
Ideally, you should consult a licensed financial advisor to explore other options such as borrowing against an asset such as reverse mortgage or mortgage refinancing.
Numerous financial products have lower rates compared to an unsecured consolidation loan, especially if you have a low credit score.
Just be very careful because refinancing against an asset will expose it if you default on your payments.
Whatever the strategy you follow, the key is to make a plan and have the discipline to stick to it.
Remember, debt consolidation is not a magic spell that can disperse your debts.
While many Australians have solved their financial woes through debt consolidation, it still requires a great deal of effort and dedication on your part to make it work.
Disclaimer: This article is for informational purposes only and does not constitute financial advice. Please consult a licensed financial advisor before you make any decision.