Don’t Make These Debt Consolidation Mistakes: 5 Things To Do First

According to Experian, in 2023, consumer debt rose to a whopping $17.1 trillion — a 4.4% increase from the year before. This was especially true of credit card debt, which increased by 17.4%. With their debts mounting significantly in recent years, many consumers are looking for a way out — and consolidation is one avenue they’re exploring.

Although consolidating debt may help you achieve your financial goals, you must make sure you don’t take any wrong turns along the way. Certain mistakes can cause detours on your financial journey and derail your plans. We spoke to three financial experts about some of the most essential debt consolidation mistakes consumers make so you can avoid them.

Mistake #1: Not Getting to the Root of the Problem

Financial mishaps aren’t just about the money we spend.

They’re also rooted in our financial beliefs and our spending habits over time. Maybe you were told as a child that money doesn’t grow on trees, so you didn’t want to pinch pennies like your parents did when you became an adult. Maybe you observed your family members regularly making extravagant purchases on credit cards, and you also adopted that same behavior.

Maybe your shopping is often driven by emotion and impulse, so you regularly overspend and max out your credit cards.

Whatever the financial story has shaped your habits, it’s essential to get to the root causes of your spending so you can change them. Taking an honest look at our money beliefs and behaviors isn’t easy, but Sharon Lechter, author of “Think and Grow Rich for Women,” warns that if we don’t, consolidating debt won’t be as useful as it should be because we’re only going to go back to the same spending habits that got us into debt in the first place.

“Doing a consolidation loan sometimes is like putting a band-aid where you need surgery. Some people go into debt consolidation, and everything gets paid off into one loan, and yet they go back and get more debt through the credit cards that are now paid off, so it’s important to pay attention to what your bad money habits are,” she explained. “People typically know they have bad habits, they just try to ignore them. You want to be moving forward financially, not backward, and debt means you’re going in the wrong direction.”

Mistake #2: Not Improving Your Credit Score

Pay close attention to your credit score if you want to consolidate debts to take advantage of a lower interest rate. If it’s not as high as it could be to get a rate that saves you money on the debt, jumping right in may not be a great idea. Instead, it may make more sense to pay off a credit card, for example, to raise your credit score and open yourself up to more favorable interest rates.

“The reason that’s important is because you’re going to qualify for better options with better credit. The solution might be just checking in on your credit. If it’s not good, you could perhaps wait a little bit,” said Laura Adams, author of “Money-Smart Solopreneur: A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers” and host of the Money Girl podcast. “You might have poor credit simply because you have a lot of debt in the first place, and that could be one reason why your credit’s not so great. You may have limited ability, depending on your situation, to improve it, but the better your credit can be, the more options you’re going to have for debt consolidation.”

However, Adams notes that waiting to consolidate debt may not be the best choice in some situations, regardless of one’s current credit score. “If you’re paying double-digit interest — let’s say, maybe even in the 20% range for credit card debt — you really want to start eliminating it as soon as possible because that high rate is just going to continue to accumulate,” she said. “So, I would say consolidating, even if it’s at a higher personal loan interest rate, might be better to begin being proactive with any interest rate reduction you can achieve.”

Mistake #3: Not Exploring the Options

Sometimes, people are so enthusiastic — or even anxious — about getting rid of their debt that they may jump into a debt consolidation loan when it may not, based on their circumstances, be the ideal solution. Just as you should evaluate if it’s better to wait to do a debt consolidation, you should also think about whether it’s a good idea at all.

In fact, other options for eliminating debt can be just as effective, or more so, depending on the circumstances. For example, if you have multiple credit cards, it may make sense to pay off the one with the lowest balance so you free up money to begin paying off another card. So, you should really think about your financial options before getting a debt consolidation loan because some strategies can be better for your situation.

“Maybe in some scenarios, it does make sense to consolidate the debt and get a lower interest rate. That’s a way you can free up cash flow. But that scenario isn’t always true. It’s not really that black and white,” said Bryan Schod, Certified Financial Planner at Luttner Financial Group. “I’d say the big mistake is going into debt consolidation blindly and not actually testing out the different options. One scenario could be great for you but terrible for your best friend.”

Mistake #4: Not Choosing the Right Terms

If you decide that debt consolidation is the right option for you, think about the terms that will be the most beneficial for your finances. For example, you may feel tempted to get a shorter-term loan to pay off the debt as quickly as possible. While this sounds like a good strategy, really consider that this will mean your monthly payment will be high.

Schod suggests that people think about whether they would be better served getting a longer-term loan and taking advantage of a lower monthly payment so they can build their savings.

“In some scenarios it actually makes sense to save and invest that money, rather than trying to pay off a loan as quickly as you can. When people don’t have a lot of liquid savings and don’t have a lot of money available, part of the reason they’re probably in this conundrum is they’re trying to pay off debts, and they’re never able to save,” he said. “Life happens, and if your car breaks down or your roof leaks, all of a sudden, you need $7,500, and you don’t have it because you’ve been throwing every extra dollar toward paying your debts off. Then you have to go back to credit cards just to pay the bills.”

On the other hand, having a longer-term debt consolidation loan can come with its own challenges. Although it does allow you to free up funds you can save, it may also impact your interest rate.

“Some companies are willing to give more favorable terms, but it does affect the interest rate. The longer you stretch out a personal loan, the more likely the rate will go up,” said Adams. “And of course, it also depends on your personal credit score, so you really need to shop around for personal loans, compare the offers, compare the monthly payments, and find a kind of a balance where you’re going to get it paid off in a good amount of time, but you’re not stretching your budget too thin to the point where you could be at risk of default.”

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Mistake #5: Not Reading the Fine Print

When considering debt consolidation, whether through a personal loan or credit card transfer, reading the fine print is imperative. You need to understand exactly what you’re signing up for so you don’t have any surprises later on.

“Check the fees. There are all kinds of fees that are charged, so make sure you check annual fees, balance transfer fees, closing costs, loan origination fees, or prepayment penalties,” said Lechter. “Go through the fine print.”