Why Debt Consolidation Loans Aren’t Always That Helpful

I’ve been working in the debt relief industry for a while now and for the longest I can remember debt consolidation loans were always considered to be the holy grail of “get out of debt” solutions. For some strange reason, consumers always flocked to this idea that a bigger and better loan would save them from all their financial troubles. Like wasn’t borrowing technically the thing that got them in trouble in the first place? I’ll never fully grasp the logic behind it, maybe it had a lot to do with the fact that debt consolidation loans were harder to qualify for than most other options. It was an obvious way to dangle a carrot in front of consumers. It was always something consumers wanted but weren’t able to acquire. People are funny that way, often times if you tell us we can’t have something it makes us want it even more. Nonetheless, these options served some people but for the most part they were really overrated. And I truly mean overrated! In a ZIRP (Zero Interest Rate Policy) economy, consolidation loans were somewhat more effective comparatively speaking since there was a much larger spread on interest rates between consolidation loans and credit card APRs. This was much of the case for 2016, 2017, 2018, 2019, 2020, 2021, etc.

However, now? In an environment where the FED Funds and Prime rate is much higher, the spread between credit card interest rates and personal loans/consolidation loans is not what it used to be. Due to this, when you factor in the cost of originating a new loan with the less substantial interest rates savings it really makes you question the efficacy of a debt consolidation loan as an option in our current environment. Debt consolidation loans also tend to have a higher monthly payment than credit card minimums, meaning more financial strain on the consumer. Which is great for those who can afford it, but for many consumers this will simply price them out of the option altogether, if credit didn’t already disqualify them.

Now I’m not saying debt consolidation loans don’t have any place in the marketplace whatsoever, that’s simply not true. What I’m saying is that as a whole consolidation loans are a highly hyped up option that is actually a lot less utilized than most people may realize. Moreover since 50% of consolidation loans today are in fact personal loans disguised as a consolidation loans, there are many personal loan options that fit into this category of "consolidation", meaning that true consolidation loans are on the decline. This is why, in some scenarios it might be better to look towards a debt snowball method or a debt avalanche method to at least try and avoid origination fees.

The general principle behind borrowing from someone to pay off other money you’ve borrowed

The idea behind a debt consolidation loan really is a trick in and of itself. If you have outstanding loans open to specific lenders, going to take out a bigger loan from another party isn’t really the most logical thing you can do. You’re just swapping one lender for another. Let’s put it this way, let’s say you borrowed $10,000 from Peter. Now let’s say you go to your friend Paul and want to borrow $12,000 to pay off Peter. Paul asks you why and you tell him because you want to pay off Peter. This might make him question your judgments. It’ll also make him more hesitant to lend you money since he knows you already owe someone else money! The same is true with lenders and credit. Consumers with the highest credit scores are usually those consumers who need credit the least. Unfortunately, this is just the way our current system works, those who don’t need credit are the ones who qualify for the best interest rates while those that need credit the most get the worst interest rates.

Loan Amount

One of the main issues that consumers run into with consolidation loans or personal loans used for the purpose of consolidating is that they don’t always qualify for the full amount. When consumers cannot acquire the full amount, the loan tends to not fix the problem. It’s akin to putting a Band-Aid on a wound that might need stitches or even surgery. It looks like it can provide some temporary relief but in actuality it doesn’t help the situation since only part of the debts are consolidated.

Not qualifying for the full amount your requested is quite common with many consumers. In this scenario many consumers look towards other loans or lines of credit to adjust but the partial consolidation doesn’t really provide the relief needed.

All in all, this is why consolidation loans aren’t all they’re cracked up to be. They aren’t easy to qualify for, they don’t provide much payment relief and they don’t always cover the full amount required. However, it should go without saying that they do serve a purpose and there are certain individuals they would be able to help.