What are the first three letters in consolidation? It’s con – and that’s how you should think of it. The most important factor is that you need to change your thinking from percentage rate to dollars of interest! You get sold (or sell yourself on the idea) that you’ll have a lower payment, pay less interest, and get out of debt faster. Right – wrong – wrong…
If I borrow five dollars from you and you charge me 80% interest for two days, I’m going to owe you the $5 and two cents interest on Friday. Big deal – who cares, right? OK, but if I borrow $5,000 at 80% interest and owe it to you for a year, and not just two days, that interest is $4,000. Now it’s a big deal: $4,000 interest on a $5,000 loan!
What matters is always how much you owe and the length of time you owe the debt. The rate is only the third most important factor. What do banks push in their ads? It’s the rate, and never the term or amount. That’s like the magician who has you looking over there while they trick you over here.
On the surface a consolidation is really easy to sell to you and seems like a win-win: One payment, combining all the debts and at a better interest rate. But since it’s not the rate that matters, you will almost always pay:
-more in total interest
-over a much longer term
-and be in debt a whole lot longer
-and in debt for a whole lot more money, too.
If you owe $3,000 on a credit card at 20%: If you want out of that rate trap and consolidate, it stretches it to five or ten years. That option will cost you a lot more in interest – not in interest rate but in interest dollars! Or just pay $250 a month and get rid of it in a year, at a cost of $600 interest.
Your car loan may have three or four years left. Make the payments and you know the end comes sooner, rather than later. A consolidation won’t get you a much better rate, but will trap you into stretching the loan another five, seven, or ten years. It quickly doubles the interest you’ll pay, not to mention you aren’t going to own the same car for t10 or 15 years!
But those aren’t even the biggest drawbacks and traps. The biggest one is that 90% of the time you will now be putting up your house for collateral. Everything up until the consolidation was either no security, such as credit cards, or was borrowing that only had something specific for collateral, such as a car. Now, in combining it all, you’re changing all that and putting up your home for security. Right now, the worst that could happen is that the credit cards will write off what you owe them and your car may be repossessed. After the consolidation – you’ll lose your home.
And the worst trap: Over 80% of people who consolidate run up their credit cards again within two years! No, you’re not the exception. Stop kidding yourself unless you cut up all the cards that got you to the edge of the cliff in the first place or you’ll be in debt for twice as much as you started with. After that, the next step is bankruptcy.
Any ‘con’ solidation should only be done as a very last resort…and even then, there are better alternatives. What seems like an ‘easy’ way out makes things worse – much worse. Don’t do it – list your debts smallest to largest and attack the smallest one with every dollar you can free up. Then move onto the next smallest. That do it yourself plan will save you thousands of dollars and a lot of years!