Should I Consolidate My Credit Card Debt?

Consolidating your high interest credit card debt into a lower interest rate debt consolidation loan seems like a prudent strategy in most cases.  After all by saving on interest charges you can pay off your debts faster. For example, if you currently owe $20,000 on credit cards that have an annual interest rate of 19%, and you pay $500 a month you will be out of debt in 4 years and 11 months. If you can reduce that interest rate to 12%, still high but not as bad as a credit card, then you would be out of debt 10 months earlier.  Sounds good right?

Unfortunately a debt consolidation loan is not always the best approach and here’s why:

consolidate credit card debt

The Interest Savings May Not Materialize

Not all debt consolidation loans will save you money in the long run.  This can happen for a lot of reasons:

  • You may not qualify for a lower interest rate loan.  Many finance companies charge up to 30% for ‘debt consolidation’ loans. That’s more than most credit cards. They entice you with low monthly payments, but the actual amount you will pay in interest can be much higher.
  • High upfront fees and higher late payment or partial payment penalties can eat away at any interest saved from your ‘lower’ interest rate loan.
  • Your payment terms may not allow for flexible pre-payment options. If your finances change and you can pay more towards your credit card debt than you thought, you might be better off with a higher interest for a short period of time than a slightly lower interest for a longer time.

Putting Assets At Risk

To qualify for a lower interest rate you may be required to provide security or collateral for the loan. This may or may not be an issue. The bank may only loan you the money if you agree to pledge your car or house as security.  If for some reason you are unable to repay the loan you risk losing your car or house. You will need to weigh the possible interest savings against the risk of non-payment.

The same applies if the bank or finance company asks you to find someone to co-sign or guarantee the loan. You must decide if you really want your parents, a family member or a friend to be “on the hook” if you default on your payments.

Consolidation Is Not Enough

While these are all important considerations, perhaps the most significant issue with a debt consolidation loan is that it does not reduce your debt.  If your problem is that you have too much debt, a debt consolidation loan does not solve your underlying problem.  Reducing the interest you pay may help, but it may not be a complete solution.  It may be necessary to explore other alternatives, like a consumer proposal.

There Are Cheaper Options

If your credit card debts are significant enough that you are having trouble keeping up with the payments, chances are you have more debt than you can repay on your own. While a debt consolidation loan can reduce your interest costs, this may not be your cheapest alternative. Before applying for a loan you should talk to a bankruptcy trustee about a Consumer Proposal. Payments are usually much lower than they would be either with a debt consolidation loan, or even if you consolidate your debt with a Debt Management Plan.

The trick is to shop around. Your situation may feel desperate but, unless your wages are being garnished, take the time to explore all your options. If you choose to get a debt consolidation loan, talk to more than one lender. If you need more than interest relief, contact a debt expert. They can help you look at your numbers and see what solution will work best for you.

Category: Credit Card Debt, Debt Consolidation |

May 21, 2014

About J. Douglas Hoyes

J. Douglas Hoyes, BA, CA, CPA, CBV, CIRP is a Licensed Insolvency Trustee and the co-founder of Hoyes, Michalos & Associates Inc., one of Canada's largest independent personal insolvency firms. As an expert in debt management, Doug has been helping people deal with debt for more than 20 years.

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