4 Debt Consolidation Traps to Avoid

As the use of credit services and products is today widely accepted as a part of life, millions of people in Australia and around the world hold debt from credit cards, personal loans and various other products. For many, accumulating debt is not a problem, as what they take on is easily manageable and they are able to meet their repayment obligations without trouble. However, financial circumstances can change or people can quickly stack up debt without considering how they will cover their repayment obligations.

Should this happen, debt consolidation can seem like an ideal solution, but if it isn’t done with careful consideration and planning it can make your debt problem worse, or leave you paying more money to clear debts than you would have originally. Debt consolidation is not a debt solution in itself, but is rather part of a process individuals can use to manage their debt more effectively or work towards becoming debt free.

Here are four debt consolidation traps you should look to avoid.

1.      Not Acknowledging You Have a Debt Problem

If you’re looking to use debt consolidation as a short-term, knee-jerk reaction as you start to struggle with your various debts, then you probably haven’t yet acknowledged you have a debt problem at all. Unless you have used your credit services and products for a ‘big ticket’ purchase, your debts will have built up over some time. While financial or personal difficulties may mean you have needed to use credit for subsistence, often debt has built up owing to people living beyond their means and not being careful with their finances.
Speaking to a debt counsellor is a great first step if you are struggling to identify or come to terms with what has caused your debt problem initially. Those who do not acknowledge they have a debt problem will often use a consolidation loan to clear credit card debt then immediately start spending on their credit cards once they have access to the full balance once again, and the debt cycle continues. Some lenders’ terms and conditions for debt consolidation loans will even ask you to acknowledge that you will not apply or accept access to further credit while paying off the loan.

“Speaking to a debt counsellor is a great first step if you are struggling to identify or come to terms with what has caused your debt problem initially.”

2.      Stacking Up New Debt Too Soon

Debt consolidation isn’t just a solution for those struggling to meet their repayments, it might be an option for those that can manage their debts from a financial perspective, but simply want to have one payment or fewer payments to make rather than several. Individuals using debt consolidation for this purpose will often retain their access to credit. This isn’t necessarily a problem, but those doing this should be mindful of spending on their credit cards and using other credit too soon.

“Debt consolidation isn’t just a solution for those struggling to meet their repayments, it might be an option for those that can manage their debts from a financial perspective, but simply want to have one payment or fewer payments to make rather than several.”

From both a financial perspective as well as the potential damage utilising more credit could do to your credit score, it is important to adhere to this point and continue to manage your debt commitments carefully. Try to utilise the mind-set that clear balances do not mean you have a clean slate, and that the debt consolidation loan you have is still a considerable commitment that should be your first priority.

3.      Not Fully Researching Your Options

There are numerous options available to consolidate debt and you should consider them all to ensure you choose the right option for you. The solutions you may be able to utilise include:

• Secured and unsecured personal loans
• Credit card balance transfers.
• Debt management plans.
• Debt negotiations and settlements.

Shopping Around

It is always worth shopping around for the best consolidation terms and considering your options. If you need to, speak with a financial adviser or lenders to help calculate what you can save using each consolidation solution. Once you have considered all options and compared them to what you are currently paying to your range of creditors, you will be in a much better position to assess whether debt consolidation is a worthwhile solution for your circumstances.

What to Consolidate

You should also remember that you don’t necessarily need to consolidate all of your debts. If you have a credit card or a loan that has a great interest rate, you can leave that out of your consolidation plan, only consolidating the debts that you can move to a more competitive, money saving rate. Overall, you need to make sure debt consolidation is really going to make a difference to your financial outlook, and not leave you paying off more over a longer period.

“You should also remember that you don’t necessarily need to consolidate all of your debts. If you have a credit card or a loan that has a great interest rate, you can leave that out of your consolidation plan, only consolidating the debts that you can move to a more competitive, money saving rate.”

Know What You’re Getting Into

The final consideration to make when researching is to beware of all the terms and conditions of whatever consolidation solution you choose. A credit card balance transfer might sound like a perfect solution, but what are your options when the 0% promotional balance ends after 12 months? ‘Get another promotional credit card’ might be the first thing to come to mind, but what if your credit rating has suffered and you can’t get one? Not only should you be sure of what you’re getting into, but if you do utilise balance transfers in this way you should make sure you’re taking advantage of the promotion to pay down as much of the balance as possible while not accruing interest.
Check that debt consolidation loans aren’t subject to penalties or fees if you’re able to repay early, whether the interest rate is fixed or variable, and whether your debt management plan or settlement means creditors will no longer be hassling you for payment.

4.      Not Having a Financial Plan

Alongside not acknowledging you have a debt problem, not having a long-term financial goal is arguably the biggest debt consolidation trap of all. This will likely lead you back into the debt cycle or being unable to apply for and access credit again in the future. It is particularly important to have a robust financial plan in mind if you are using debt consolidation as a means of clearing your debts in full.
Your plan should start from the moment you begin considering consolidation and looking at your options, so that you commit to an affordable repayment plan but one that will also reduce your debts in the quickest possible time. Create a sustainable budget for your lifestyle so that you understand how you can enjoy life and meet your financial needs and obligations without turning back to debt now or in the future. As with the acknowledging of debt, if you are struggling with this step finding a debt and credit counsellor may be of help. Once you get started with your financial planning, you’ll probably find living with a budget and fresh monetary perspective easier than you imagined, and start to enjoy the benefits of a debt free financial future.

“Check that debt consolidation loans aren’t subject to penalties or fees if you’re able to repay early, whether the interest rate is fixed or variable, and whether your debt management plan or settlement means creditors will no longer be hassling you for payment.”

Debt consolidation is a great solution for managing debt, if used correctly. Contact Constancy Wealth Management to discuss your debt consolidation requirements and decide whether this is a suitable credit product for you.

What you need to know

Constancy Wealth Management is an Authorised Representative and Credit Representative of AMP Financial Planning Pty Limited ABN 89 051 208 327 AFSL 232706 and Australian Credit Licence 232706. This information does not take your circumstances into account, so read the relevant disclosure documents and consider what’s right for you. If you acquire an AMP product or service, AMP companies and/or their representatives will receive fees and other benefits, which will be a dollar amount and/or a percentage of either the premium you pay or the value of your investments. Ask us for more details.

This post contains information that is general in nature. It does not take into account the objectives, financial situation or needs of any particular person. You need to consider your financial situation and needs before making any decisions based on this information