When debtors wonder whether debt consolidation makes sense, they are really faced with two possible options. Both options often distract from the right goal, which is (or should be) to improve the debtor’s personal finances. Whether debt consolidation makes sense at all really comes down to that question: “Will this improve my financial well-being?” Keeping that objective mind, facing these two options becomes less complicated.
The first is whether debtors have the ability to draw on equity in their home to consolidate consumer debt. Now this was a topic of discussion for a recent a recent article but the thought behind using equity is twofold. Primarily, debtors should use home equity to reduce total average interest costs and, secondarily to increase cashflow.
In this case, whether debt consolidation makes sense will depend on how the debtor can curtail (or ideally eliminate) future consumer debt. Debtors who simply rack up more and more in consumer debt following a debt consolidation will simply erode their net worth on a continual basis and, truthfully, their problem is not a debt problem, it is a spending problem.
The second option facing debtors will be the issue of an unsecured debt consolidation loan. Where consolidation loans secured by home equity will normally result in lower rates, unsecured consolidation loans may not. Therefore, debtors with only this option available to them will aim at improving cashflow and not necessarily total interest costs.
When cash flow becomes the only factor, determining whether debt consolidation makes sense is a very simple task. All debtors need to do is add up their current bill payments and compare it to the payment on the new consolidation loan. If the new loan payment is lower, than cash flow has improved. In cases where cash flow has improved, debtors should then determine whether it is sufficient to keep them afloat. If not, other options need to be explored.
Without question, consolidating consumer debt with home equity provides the ideal solution to debtors. In instances where there is no home equity or the equity is not enough, debtors need to work harder to determine whether debt consolidation makes sense with an unsecured loan. On such loans, rates will be higher and repayment terms shorter, meaning higher payments than, say, a refinanced or second mortgage. Since rate is the only controllable factor, debtors need to find the lowest-rate loan possible (see below) so that payments are lower.