On the surface, using loans to consolidate credit card debt appears to be a good idea. After all, debt consolidation loans can help to lower the interest rates on your debt, reduce your monthly payment obligations, and offer the convenience of one single monthly payment.
So what's the problem?
I'll tell you.
Credit cards are based on a type of credit known as revolving credit. With revolving credit you can borrow up to a set limit, pay it off and borrow again. This differs from a regular loan where the funds are advanced to you up front and you pay the loan off over time reducing the amount of credit extended to you as you pay down the loan. Once the loan is paid off, you no longer have access to that credit.
What does this have to with loans to consolidate credit card debt? Lots. And I will tell you why.
Nobody gets into debt trouble without first being extended credit. The debt problems arise when people take advantage of that credit by borrowing against it, and then find themselves unable to pay the money back. And the more credit someone has, the larger the amount of debt they could potentially go into.
That being the case, it almost seems counter intuitive that someone having trouble handling their current debt (ie. they already have too much credit) would seek a solution (ie. loans to consolidate credit card debt) that involves taking on more credit. But that is exactly what happens when a debt consolidation loan is used to pay off credit card debt. And the potential pitfalls can be devastating to your finances. Here's an example.
Let's say that you have $20,000 worth of credit card debts with an interest rate of 19%. You figure if you could just get a new loan, with a lower interest rate, and use the funds to pay off those cards, your debts would be at least manageable. With this in mind, you go out and get two new loans totaling $20,000 at 8% interest. By doing this you are saving yourself over $2,000 per year in interest charges right out of the gate. And that's a good thing of course. As well, and depending on the terms of the new loans, your monthly debt payments will also likely be lower, helping you to more easily meet your debt obligations.
Lower payments and less interest. Both good things. But here's the problem...
If you are like the majority of people who secure a debt consolidation loan to pay off credit card debts, you will do so without addressing the underlying problems that got you into that credit card debt in the first place. And if you fail to correct your behavior when it comes to handling your money, you are going to continue to get yourself into more debt trouble. Having said that, let's fast forward 18 months after you have used these loans to consolidate credit card debt.
A year and a half down the road your $20,000 worth of loans to consolidate credit card debt have been paid down to $18,000, so you are making some headway with your debt. However, when you paid off your credit cards 18 months ago, you didn't cancel them. Therefore, your revolving credit on those cards went up by $20,000. In other words, you instantly had access to that $20,000 on your credit cards to use for more purchases.
But you wouldn't make the same mistake twice by running up credit card debt you couldn't afford to pay off, would you? Well, unfortunately if you are like a lot of people that are in the same boat as you, you would. In fact, let's say (for the sake of this example) that after 18 months you find yourself with $8,000 in new credit card debt. Let's do a tally.
$18,000 left on the loans to consolidate credit card debt, plus $8,000 in new credit card debt, equals $26,000 in total debt.
And now you have credit card payments and two loan payments to deal with.
The lesson here is this. More credit does not solve the problem of having too much credit and debt. Instead, you must solve the root of the problem, which in most people's cases is spending more than they earn. How do you accomplish this? Start with a thorough analysis of your finances including all of your income and all of your expenses (including your debt payments). Then, prepare a budget that allows you to live within your means, pay down your debts, and put money aside in savings. If you need help with this, I suggest that you speak to a qualified credit counselor. You can find one locally or online if you prefer. And if appropriate, they can also recommend alternative solutions to your debt problems that do not involve loans to consolidate credit card debt.