Why Debt Consolidation Can Be A Cruel Mirage

Hand with pen and checkbookIf you don’t know what a mirage is, the Microsoft online dictionary defines it as an “optical illusion” or “something illusory”. Probably the most common example of a mirage can be found in those old westerns where thirsty cowboys thought they could see water ahead of them but where there was only sand. I got to thinking about this when I came across an article about debt consolidation on daveramsey.com.

The lure of debt consolidation

On the face of it, a debt consolidation loan can seem a good way to get control of your debts. All that’s necessary is to march down to your bank or credit union and borrow enough money to pay off all your creditors. You should end up with a payment that’s much less than the sum of the monthly payments you’ve been making. Your interest rate will be lower. And you’ll have only one payment to make a month versus all those other payments you’ve been juggling.

Why it’s a mirage

The reason why debt consolidation is a mirage or something illusory is because you’ll feel that you’ve done something about your debt problem while the debt is still there. All you’ve done is moved it from one set of creditors to a new one. And as the old saying goes, you can’t borrow your way out of debt.

The statistics

According to this article, about 78% of the time after a person consolidates his or her credit card debt, it just grows back. The reason for this is simple. It’s because the person still doesn’t have a plan to either pay cash or not buy at all. Plus, he or she probably hasn’t saved for “unexpected events” that turn into debt when they occur.

Why you get lower payments

The fact that you get a lower payment with a debt consolidation loan is also a mirage. This is because the term of the loan has likely been extended to as long as seven, 10 or even more years. If you were to refinance your house to pay off those bills you’d literally be paying on that loan for 15 or even 30 years. You would be paying less interest each month but would be paying much more interest over the life of that loan. For example, if you were to borrow $15,000 at 5.4% with a term of seven years, you’d pay a total of $3046.51 just an interest. So, the total cost of the loan wouldn’t be $15,000. It would be $18,046.51

Dave’s answer

According to Dave Ramsey, the real answer to dealing with debts isn’t to get a debt consolidation loan. It’s to change your habits. You need to create a budget and a written plan and stick to them. You might take extra shifts at your job or a second job to start paying off your debts. The simple answer is that you need to live on less than you earn and use the difference to pay off your debts. This is not rocket science. But it is emotional because it requires you to make sacrifices, learn to live within your means and stop impulse buying.

Another option

Debt settlement is another option worth considering. This is where you hire a company like National Debt Relief to contact those creditors where you have unsecured debts and settle them – probably for 40% or 50% less than you actually owe. It will take you less time to pay off your debts because you’ll have less debt to pay off. In fact, most National Debt Relief clients are completely debt free in two to four years – depending on how much they owed. Plus, their payment plans are always affordable

You can click here to read the entire Dave Ramsey article