Why is debt consolidation a bad idea?

Debt consolidation is a bad idea if it does not save you any money. This happens when the interest rate on your new loan or line of credit ends up being higher than that of your existing debts, which mostly defeats the purpose of consolidation. In that case, the only benefit would be having all your debts in one place. Debt consolidation may be a bad idea in other situations too, like if you work with a misleading company or consolidate right before a major purchase.

When Debt Consolidation Is a Bad Idea

• When the APR is higher than on your existing debts
• When your "debt consolidation" service is really debt settlement
• When you're about to buy a house or car

If your credit score is worse than when you originally took out your existing debts, it will be hard for you to find a consolidation loan with a good rate. It's a good idea to check your credit score before applying for any debt consolidation loan and to spend a few months improving your credit score if needed.

But even if your credit score is in good shape, you still have to watch out for the wrong types of companies, as well as make sure there aren't any major purchases in your near future.

Debt Settlement Services Disguised as Debt Consolidation

One major situation where debt consolidation is a bad idea is if you're using a "debt consolidation" service that actually turns out to be a debt settlement company instead. Rather than negotiating for a lower interest rate, debt settlement companies try to get your issuer to accept a lump sum and forgive the rest of your balance.

The problem is that debt settlement is a negative item that remains on your credit report for 7 years. In addition, debt settlement companies often have you avoid making payments to the lender for a while to get better negotiating power. That's very bad for your credit score, too. On top of all that, debt settlement companies can charge expensive fees.

Debt Consolidation Before a Large Purchase

Debt consolidation is a bad idea if you're about to buy a house or a car. Getting a debt consolidation loan or line of credit will damage your credit score in the short term because of the hard credit pull triggered by the application. Working with a debt consolidation company also damages your credit if you default during negotiations.

If you're about to make a major financial decision that requires a credit check, you want your credit to be as good as possible. However, at other times, debt consolidation can be a good idea. The credit score damage from applying for a debt consolidation loan is usually limited to 5 to 10 points, which you can rebound from after a few months of on-time payments.

You can predict how debt consolidation might impact your credit score by using WalletHub's free credit score simulator.

Consolidating debt with a personal loan can be a good idea if you can get a new loan with favorable terms and a lower interest rate than current debt. Whether you can qualify for a consolidation loan depends on your credit scores, income and other financial factors.

If you qualify, make sure you understand the loan terms, have a plan to pay it back and get your spending under control so you don’t end up deeper in debt. If the conditions are right, a debt consolidation loan can be a good tool to help you become debt free faster.