# Debt consolidation: when it works

Consolidating balances can lower the monthly payment while raising the total cost. How to tell the two apart before you sign.

Consolidation is not a product, it is a comparison. You are trading several balances for one, and the only question that matters is whether the total cost of the new debt is lower than the total cost of the old debt over the same period. Lower monthly payments are easy to achieve by stretching a term, and that is the move most consolidation offers are built on.

## The test to apply before anything else

Write down, for each existing balance, the balance, the interest rate and the minimum payment. Add up the total interest you would pay if you cleared each one at the current payment. Then do the same for the consolidation offer. If the consolidated total interest is higher, the offer is a term extension wearing a helpful face, not a saving.

- Compare total interest over the same repayment period, never monthly payments.

- Check whether the new rate is fixed or variable.

- Check whether there is an origination fee, and whether it is deducted from the amount you receive.

- Check whether the new loan is secured. Secured consolidation puts an asset at risk.

## Why the monthly payment falls

A payment falls for exactly two reasons: the rate is lower, or the term is longer. Only the first is a saving. A five-year loan at a lower rate than a credit card still costs more in total than clearing the card quickly, because five years of interest at any rate is a long time.

Run the numbers both ways before you sign. Enter the balance and rate into a payoff calculator, then compare a payment that clears it in two years against one that takes five. The difference in total interest is the price of the lower monthly figure.

## Where consolidation genuinely helps

It helps when the rate is genuinely lower and the term is not stretched beyond what you were already paying. It helps when several high-rate revolving balances become one fixed instalment, because a fixed instalment cannot be re-borrowed the way a credit line can. It helps when a single payment makes the debt feel finite and easier to attack.

It hurts when the credit lines that were cleared stay open and get used again. That is the most common failure, and it doubles the debt rather than consolidating it.

## The two things that make consolidation fail

The first failure is re-borrowing. Consolidation clears the revolving balances, which frees the available credit, and the freed credit gets used again. The result is the original debt plus the consolidation loan. If you consolidate, close the cleared accounts or reduce their limits, and expect a small credit-score dip for doing so; it is cheaper than the alternative.

The second failure is choosing the offer with the lowest payment, which is usually the offer with the longest term and the highest total cost. The lowest payment and the lowest cost are rarely the same offer.

## Secured against unsecured: the real trade

A secured consolidation loan, whether a home equity loan, a home equity line of credit or a second mortgage, is almost always cheaper per dollar because the lender can recover the debt from the asset. It also converts an unsecured debt, which in the worst case is discharged in bankruptcy, into a secured debt, which is not. Default on it and you can lose the home.

That is not a reason never to do it. It is a reason to size the payment so it survives a loss of income, and to treat the property as collateral rather than as a cheque. If you go this route, read the total-cost-of-credit disclosure carefully, including closing costs, whether the rate is fixed or variable, and any prepayment penalty.

## Credit counselling and the non-profit route

In both the United States and Canada, non-profit credit counselling services will review your whole position, negotiate with creditors and administer a debt management plan. They are usually free or low cost and regulated in most places, and they are a better first call than a lender if you have more than one delinquent account.

Distinguish a genuine non-profit counsellor from a for-profit debt settlement company that markets under a similar name. Ask who is paid, how, and by whom. A settlement company that wants a fee before it has settled anything is a warning sign in any jurisdiction.

## What to keep in writing

Keep the original statements for every account you consolidate, the consolidation agreement, the disclosure of the total cost of credit, and proof of each payoff. Payoffs go astray and reappear as collections more often than lenders admit, and the only defence is a record showing the creditor was paid.

Before signing, ask for five figures in writing: the amount borrowed, the finance charge in dollars, the annual percentage rate, the payment schedule and the total of payments. If any of the five is missing, the offer is not yet comparable with the others.

## Related pages

- Debt consolidation costs

- Debt payoff calculator

- Loan payment calculator

Source: https://costreference.com/guides/debt-consolidation-when-it-works/