Pepperdine Graziadio Business School Professor Brandon Parsons on Potential Benefits of Debt Consolidation Loans
Brandon Parsons was asked by WalletHub if debt consolidation is a good move for someone with bad credit.
“Although it depends on each individual’s specific financial situation, yes it can be.”
Here are some potential benefits:
Action – You will gain some relief and peace of mind knowing that you are actively dealing with the problem. It is an important initial step. Often, ignoring the problem, or rationalizing that it is not an issue, can create a larger problem. Specifically, as you miss payments or altogether stop paying, interest rates increase to the default rate (e.g., a credit card default rate is around 30%). The default rates are much higher than regular rates. Therefore, the longer you wait to act leads to much larger balances that require larger payments and/or time to pay off.
Simplicity – A big benefit of debt consolidation is moving multiple accounts into one single payment. When you only have one account, instead of multiple accounts, you are less likely to make an oversight and miss a payment which again leads to a higher default interest rate. Also, it can help make tracking your progress easier since you are analyzing one account instead of many.
Lowered Interest Rates – Along with simplicity, a debt consolidation loan could significantly lower your interest rate especially if you are paying much higher default interest rates. Additionally, the lower interest rate will help you get out of debt sooner relative to high default interest rates. For example, the difference in interest rate accruals between 10% (average debt consolidation loan interest rate) and 30% (average default rate on a credit card) on a $10,000 balance is $2,000. You will get out of debt much sooner if that $2,000 difference is used towards the $10,000 balance and not on interest rate accruals.
Improved Credit Score – You may see an increase in your credit score as those accounts in default are paid off with the debt consolidation loan. Do keep in mind that creditors will see the debt consolidation loan as a potential indicator of previous financial problems. That said, it is likely creditors prefer to see a debt consolidation loan instead of several accounts in default.
Stop Collections – A debt consolidation loan that pays off accounts that are in default will stop collection calls and lessen the likelihood of judicial proceedings that end in potential wage garnishments.
In addition, Parsons offered insight for people with bad credit who are in the market for a debt consolidation loan:
Urgency – If you are in financial trouble, do not wait until you are in default to act. You want to remain in good standing to avoid a record of default on your credit report as well as those high default interest rates. Delaying action can lead to bigger problems that take more time and money to fix.
Consider Costs – Whether a debt consolidation service or a debt consolidation loan, be sure to consider the costs. It is important to shop around. The lower the cost of the loan or service, the more of each payment will go toward the balance instead of interest accruals.
Bankruptcy – After crunching the numbers when considering options with debt consolidation, be sure to determine if the payment is feasible based on your individual budget. If it is clear, you are unable to afford the debt consolidation payment, it might be an indication that bankruptcy is more appropriate given your financial situation. This is not a move that should be taken lightly and would require consultation with legal experts.*
Future – Debt consolidation does not fix future financial problems. It is important to act to align revenue with expenses going forward. If there is a future imbalance, financial problems will continue to arise. There are times when uncontrollable factors lead to financial problems (e.g., a loss of a job or a medical event). Unfortunately, there can be little you can do to mitigate uncontrollable factors other than increase the size of your savings. Do your best to manage those factors you have some control over well (e.g., limit spending on unnecessary items).
The full article is available here.