The Pros and Cons of Debt Consolidation

If it feels like you are in a never-ending debt free fall, now's the time to get on solid ground. "Debt is your financial well-being's kryptonite," says Lou Cannataro, founder of Cannataro Park Avenue Financial. “If you are supporting debt, this limits your ability to save and invest to build your net worth. Supporting a high monthly burn [expenses] greatly slows or derails your ability to create financial control in your life."

According to the New York Federal Reserve, household debt in the U.S. reached $16.15 trillion dollars in the second quarter of 2022. That's a lot of people potentially looking for a lifeline. Luckily, there are quite a few solutions up for grabs. "The first step," Cannataro says, "is to try and bring various debt together looking to minimize costs and payments." What follows are ways to build on the consolidation idea and fix the free-fall—while also making sure the moves are the right ones for you:

The benefits of debt consolidation—and possible pitfalls

The idea behind debt consolidation is to gather your various debts into one loan or balance transfer with a lower interest rate while setting up a manageable monthly fee paid over a set period of time. This allows you to pay less interest and potentially get out of debt more quickly.

“When you consolidate, you can reduce the interest being paid, shortening the time needed to become debt free," says Cannataro. “Also, consolidation could mean one payment each month versus managing a new bill possibly every week, with the challenges that may bring into your life.

There are a few different strategies for consolidating debt, each with their positives and negatives. Options range from taking out a home equity loan or home equity line of credit, moving your debt to a single low-interest credit card, getting an unsecured personal loan or using a debt settlement agency to negotiate lower payments.

There are many benefits of debt consolidation. But it makes sense to tackle the issue with your eyes wide open, considering all the pros and cons of debt consolidation practices:

Pros of debt consolidation

1. Make your debt easier to manage: Taking control of your situation and proactively making a plan to fix it gives you some peace of mind, not to mention reduces the stress of managing multiple payments with different due dates.
2. Cut your interest charges: The average individual has 3.84 credit cards—with typically high interest rates. Not to mention car payments, medical bills, mortgages, and student loans. By settling high-interest debts with a lower-interest loan, you can reduce the money you burn in interest.
3. Reduce your credit utilization score to improve your credit score: Your credit utilization score, or the ratio of your debt to your credit limit, may impact your credit score. By paying off multiple debts through consolidation, you will improve your credit utilization score by using less of your available credit, and therefore possibly your credit score, more quickly.
4. Debt settlement programs may hurt your credit score: Debt settlement programs, where you hire a credit counseling agency to negotiate lower payments for your debts, may sound appealing, but they can actually hurt your credit score if the debt is not paid in full or if you miss payments. There can also be costly fees associated with the service, as well as scams.

Consolidating your debt is not a get out of jail free card. Racking up that debt happened for a reason. To get on solid financial footing, you need to be ready to make personal spending changes.

“If you have not truly committed to curing the problem of not living within in your means, a successful consolidation can quite often set off a new round of spending. Then, in a short while, you may have dug an even deeper hole," Cannataro says, which leads to some cons to consider before consolidating your debt.

Cons of debt consolidation

1. May entice you to put new debt on your zero balance credit cards: Once you have cleared the debt on your credit cards to a zero balance, it can be tempting to start making new charges on them, which will increase your overall debt. Needless to say, this new debt can really derail your attempts to get back on track. Some people cut up their credit cards to prevent this behavior from happening. Others close their accounts (which may also hurt your credit score).
2. Not every debt consolidation offer improves your interest charges: Make sure to move credit card debt from higher APR credit cards to lower APR debt consolidation loans or balance transfers. If the APR is not lower, you can increase your interest charges, which is exactly the opposite of what you are trying to do through debt consolidation.
3. Debt counseling fees can add to your expenses: Taking a debt consolidation loan will move your debt, but it often means meeting with a debt counseling agency to put together a strategy for tackling your assorted debts. You, in turn, pay them a set monthly fee. This may provide a more comprehensive program to improve your financial status but also eat into your finances. You should be aware that these agencies are also varied and should be approached prudently to avoid scams. Be sure to use an agency accredited by the National Foundation for Credit Counseling or the Financial Counseling Association of America.