Debt consolidation may seem wrong, but it can work

Many people owe too much money, as it is just too easy these days to use a credit card instead of cash. Through repeated use and carelessness, the debt piles up and soon the debtor owes more money than he or she can reasonably repay. As credit card companies are now requiring minimum monthly payments of about 4% of the outstanding balance, many consumers are simply unable to put a dent in the amount that they owe. A late payment can make the situation even worse, as credit card companies have no problem attaching late fees and penalties to the amount the debtor already owes. What can someone do in this situation? 

The answer may seem a bit nonintuitive, but the solution might be to borrow more money. Borrowing more money when you already owe more than you can handle may seem rather strange and not very productive as borrowing money is the cause of the problem. By using a financial tool called debt consolidation, debtors can borrow more money and ease their debt burden at one time.

Debt consolidation involves borrowing more money not to add to the existing debt, but to replace it. It’s no secret that credit card debt is expensive; the average interest rate is about 19% per year. There are plenty of ways to borrow money at more affordable rates, including unsecured personal loans and home equity loans. The savvy debtor will apply for a new loan, such as a home equity loan, in an amount that equals the sum of all of his or her existing debt. If you owe $15,000 on three different credit cards, the solution would be to borrow $15,000 more and use that money to pay off the credit cards. A home equity loan might have an interest rate that is only half of the rate charged by credit card companies, making the payment much more affordable. The borrower will have the convenience of paying less interest and making only one debt reduction payment each month. The borrower saves money by paying less interest and has fewer payments to make, resulting in a win-win situation.

Combining your bills is far from a perfect solution, however. Failure to make the payments regularly on the new loan will put the debtor back in trouble. Failing to secure a loan at a lower interest rate will only add to the financial burden. Using credit cards again after paying off the bills can actually make the situation worse, as the capacity for debt is now much higher than before.

Consumers with financial problems are urged to seek financial assistance or credit counseling before combining their bills with new loan. The benefits of combining bills with a single loan are significant, but the pitfalls are dangerous. This is not something to jump into without first giving it a bit of thought. If utilized wisely, a new loan can help an overly burdened consumer out of financial trouble, even though it seems like the last sensible thing to do.

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