Debt Consolidation – Beneficial or Detrimental?

by Ken Rupert. 0 Comments

Recently I was asked to give my thoughts on debt consolidation loans. The reporter asked the following three questions. What is debt consolidation? What are the pros and cons of it? What are some of the misconceptions people have about it? As the Apostle Paul once wrote, “(I) am not saying this because I am in need, for I have learned to be content whatever the circumstances. I know what it is to be in need, and I know what it is to have plenty. I have learned the secret of being content in any and every situation, whether well fed or hungry, whether living in plenty or in want.” When I was younger I had practiced the behavior of artificially inflating my income with debt. I was “in need” and I supplemented my income with the use of debt. Eventually the debt I owed exceeded the amount of money I earned. So, I visited a debt consolidation company. During this experience, I learned it was more beneficial to accelerate my payments then it was to have a lower interest rate on all of my debt. Let me start with a simple truth: Debt is a wealth killer. The premise behind debt consolidation is a myth. Grouping together debt looks appealing to those who have high levels of debt and low levels of resources (it did to me). However, debt consolidation is about augmenting the three constrains of debt: length of time (life of the loan), interest rates, and amount owed. These three constrains are adjusted to present a more palatable payment, but does little to actually relieve the amount of debt. A debt consolidation loan actually increases the amount paid over the course of the loan. It increases the amount owed through the smoke and mirrors of reduced monthly payments. Typically a person will have varying levels of debt at varying levels of interest. Making the minimum payment on these debts most often results in the person making payments for many years beyond the useful life of the items purchased. Debt consolidation simply combines all of the outstanding debt, calculates an interest rate that guarantees a desired level of return and spreads out the lifecycle of the loan to make the payments palatable. There are only three ways to reduce payments on debt. First, lower the interest rate, second, extend the life of the loan or third, reduce the amount owed. In debt consolidation, all three are manipulated to increase the gain of the debt consolidation brokers and subvert the perceived gain to the client. Since the amount owed is not being reduced, the debt consolidation broker often reduces the interest rate low enough to attract a client and then extends the life of the loan to make the payment palatable. Although this typically provides the client with a more manageable payment in the short term, the client ends up paying more out in the long term. The best way to pay off debt is not to refinance the debt (a practice known as using debt to pay off debt); rather it is to make accelerated payments greater than the minimum payments due. Of course it is incumbent upon the person to stop using debt to artificially inflate his or her income. If you want something but cannot afford it, then you have to tell yourself “no.” I personally do not believe that the short term benefits of debt consolidation erase the long term consequences. It merely shifts the equation from making larger payments for a shorter period of time (paying down debt as fast as possible) to making lower payments for a longer period of time. Any mathematician can tell you that this equation works in the favor of the debt consolidation brokers. Debt consolidation is not about responsible debt management. It is about committing unearned future income to a payment structure that favors the debt consolidation brokers, for longer periods of time and robs the person of the potential to build wealth for retirement. It also results in not being able to get what you need because you have gotten all you want. When your resources dry up, you have to say “no” to the very things you need such as food, shelter, transportation, and utilities, or, you will have to start to default on the debt. Neither situation is healthy for your financial stability. Debt and debt consolidation loans are really two peas in the same pod. Both are forms of debt. One is more structured and has longer life than the other. However, both are detrimental to your ability to sustain financial stability. Financial stability means that you have more coming in than you have going out. This is where you gain the ability to save and invest. Artificially inflating your income through the use of debt and debt instruments will eventually rob you of future unearned income. Debt preserves the financial commitment of a purchase, often beyond the usefulness of the purchase. The only debt that usually does not result in this equation (preserving the financial commitment of a purchase often beyond the usefulness of the purchase) is mortgage debt. Going back to the original questions: What is debt consolidation? A myth that robs you of future resources and your ability to save, invest, and build wealth. What are the pros and cons of it? The short term pro is that it often tricks the person into believing that debt has become more affordable. This gives the person a false sense of security. However, if the person fails to stop the artificial inflation of his income through debt, he will again find himself sitting at the desk of the debt consolidation broker once again trying to readjust his debt to make life more palatable. What are some of the misconceptions people have about it? Some believe they can afford the continued use of debt as a financial tool. Unfortunately, they will be robbed of future earnings and be unable to build wealth and attain financial stability. Learn to have a healthy distain for debt. Do not use debt to finance your present at the expense of your future. I have been there and done that. By God’s grace, I will not return to that time in my life. If you are there now and desire to learn a different way, I will be facilitating a Dave Ramsey Financial Peace University class starting April 4, 2013. You can register for the class by visiting my website and clicking on the link for Financial Peace University located on the Happenings page in the Upcoming Schedule of Events section. The class code is 228086. It is being hosted by the Marriage & Relationship Education Center located at 255 Clifton Boulevard, Westminster, MD 21157. Get all of the details at the link mentioned above.

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