Debt consolidation: how to use it wisely

Debt consolidation can be a useful way to pay down debt. But many people use it without curbing overspending.

Yesterday, I heard a very interesting story on NPR that focused on Dave Ramsey looking at Greece’s debt situation through a personal finance lens. Without going into the politics of it, Dave made the astute observation that if a person behaved in the same way that Greece (or any other nation verging on default) behaved, they would be in a deep, deep personal crisis.

The story ended with a very interesting line:

Ramsey says the data from his world of personal financial advice is not encouraging: Most people who consolidate their debt are back in trouble within two years.

This statistic isn’t surprising to me in the least. Zero-interest balance transfers, home equity loans, and the like can go a long way toward turning high interest debt into much more manageable low interest debt.

Most of the time, debt consolidation is used merely to give a person enough breathing room to continue their life as usual. It’s just another way to move around bills in the short term to extend the party a bit.

Of course, some of the time, debt consolidation can be a great tool for getting your house in order.

The difference between the two groups isn’t measured in dollars and cents. It’s measured in whether or not the debtor is actually committed to financial stability or if they just want an easy route to more short term stuff and long term problems.

Here’s the real truth. If you are in a situation where debt consolidation looks appealing to you, it won’t help even a little bit if you don’t get your spending under control. In fact, it’ll probably make things worse over the long run.

To get into that situation, you have to be spending more than you earn. In order to get out of the situation, you have to be spending less than you earn. If you’re not committed to making the changes it takes for that, then you’re just shifting the dirt around to dig yourself a deeper grave without the walls collapsing in on you. You’re reducing the interest rate on some of your debt, which gives you enough monthly cash flow to start racking up more debt, which is completely in accordance with your lifestyle.

Before you consider consolidation, get your spending under control. If you can’t go more than a paycheck or two without spending more than you earn, then debt consolidation will do nothing more than make the long term problem worse for you (simply because it enables you to get into even more debt).

The key is to get your spending under control, not finding a great debt consolidation program. Using debt consolidation as a means to extend your overspending ways is, as Dave puts it so nicely, an “orbital of stupid.”

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