When it comes to personal finance, I’m a strong believer in simplicity. Although I’m still trying to break the habit of claiming to be bad at math, I know that the more complicated my financial plan is, the less likely I’ll be sticking to it.
That’s the thing about personal finance. There’s a logical element, in which we focus on the choices that make the most financial sense. And then there’s the emotional element, in which we recognize our abilities and limitations and try to find a balance that will challenge us without pushing us to give up altogether. My emotional element needs simple solutions so that I can maintain motivation towards reaching my financial goals.
This delicate balance between emotion and logic is an important part of making decisions on financial solutions. Problem is, many financial solutions are marketed as blanket solutions — and that can get consumers into trouble.
Case in point: debt consolidation. In the right circumstances, debt consolidation can be the key to breaking through the clouds of a tough debt journey. In other cases, it can lead to even more debt. It all depends on your situation and, well, your emotions.
Defining Debt Consolidation
Debt consolidation is a simple concept that’s often defined incorrectly. Debt consolidation is the act of using new credit to pay off debt. This can take the form of a loan or credit card that pays off multiple other loans or credit cards and it often comes with a lower interest rate. A lower interest rate combined with making only one payment equals the simplicity and financial benefits that can help you pay debt off faster.
But if you were to research debt consolidation right now, chances are you’d see a lot of results for debt management and debt settlement companies. Let’s be clear: debt management and debt settlement are not the same as debt consolidation. These companies promise you debt relief that takes on a different — and sometimes costly — format.
You don’t need a company to consolidate your debt for you. You can consolidate your debt through a balance transfer credit card, a home equity loan, or an unsecured installment loan such as peer-to-peer loans. Once approved, the new credit will be used to “purchase” and pay off your debt so that you’ll only have one payment to make moving forward.
On paper, it sounds like the perfect solution. Lower interest allows more of your money each month to go directly to your principal balance. And having only one payment to make simplifies your life. But the truth about debt consolidation is that it doesn’t always work out this way.
Why not? Because the key to debt payoff lies in changing your financial behavior.
Let’s say you obtain a zero percent interest rate balance transfer credit card that expires in six months. It sounds great — no interest for half a year can help you make a serious dent in that total debt balance! But what happens if you don’t pay it off and then you get another balance transfer… and then another… and then another? Suddenly your shortened debt journey doesn’t seem quite so short.
Or worse, what happens if you continue to use a credit card while paying this one off? Not only can you skew the interest rate if you’re using the same card (since purchase APRs and balance rate APRs are often drastically different), but you’ll dig yourself further into debt if you can’t pay those purchase balances off by the end of the billing cycle.
No matter what sort of credit you use to consolidate your debt, you won’t truly change your debt situation unless you change your financial behavior.
The True Key to Paying Off Debt
Given the right circumstances, debt consolidation is a great tool to paying off debt faster. But with it needs to come a healthy dose of introspection. Why did you get into debt? Was your income too low to meet your needs? Did you encounter an emergency that set you back financially? Or were you simply not tracking your spending?
Debt can happen to anyone — regardless of income level — so answer these questions honestly. The more honest you are with yourself, the more likely you’ll solve the problem. Perhaps you need side income or to transition to a higher earning career. Perhaps you need an emergency fund. Or perhaps you just need a budget you can stick to. Whatever the case, find a customized solution that works for you by balancing your emotional and logical needs. Only then can you truly shorten your debt journey and carve a path to financial freedom.
Shannon McNay is a member of the DailyWorth Connect program. Read more about the program here.