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If you have ever vowed to eliminate your credit card debt or felt like you were in over your head with your finances, you have likely considered getting a consolidation loan.  The idea is sound; pay off all the little outstanding debts that are collecting interest each month with one large loan that will have a substantially lower interest rate.  It is true that doing this will likely make it easier to eliminate the little debts, but consolidation loans come with their own financial pitfalls.  Because of these potential traps, consumers should be wary about signing up for a debt consolidation loan.

Debt consolidation is not always the right choice for each individual.  It’s always a good idea to speak with a certified credit counsellor about what is right for you and if consolidation is something you should consider.  It’s important to remember that consolidation is not a free service.  It can help alleviate some of the pressure around your finances but will not fix the issue that caused your financial trouble in the first place.

Here are the four most common debt consolidation traps to avoid if you find yourself looking into a consolidation loan.

  1. High Fees

As I mentioned above, debt consolidation is not free.  It can be a good way to get interest rates under control but beware of high up front or monthly fees.  Most finance companies that offer consolidation loans will charge exorbitant fees and interest rates for the privilege.  Request a list of the fees in writing and understand what they will cost you in the long run.  There should be no confusion around what this loan will cost you over its term.  If the company will not provide a breakdown of the fees, go somewhere else!  You want to work with a company that is clear and upfront about what they will charge you for this loan.

  1. High Interest Rates

With a consolidation loan, you combine all your smaller loans into one loan that has payment you can afford each month.  In theory, this should be better for you as it will be easier to manage the payment from month to month and the loan will eventually come to an end.  However even if the monthly payment is lower, it doesn’t mean you are not spending too much.  Some companies charge very high interest rates for consolidation loans to go along with the monthly payment.  They just hide the increased interest over a longer period of time.  If the interest rate seems too high, look somewhere else.  You can shop around for a better interest rate as long as your credit rating is in good standing.

  1. Pay off the Right Debts

It may be tempting to pay off all your debt with a consolidation loan so you will only have one payment to make each month.  This could be a huge mistake as some forms of debt are better than others.  Car loans or student loans with low interest rates can be considered “good” debt and shouldn’t necessarily be paid off with a consolidation loan.  Focus on the high interest loans such as credit cards, overdraft, and payday loans.  These loans can cost you a lot of money and may take a decade or more to pay off.  Rolling your low interest debts into a consolidation loan may end up costing more over term of the loan.

  1. Running up Debts Again

The biggest mistake people make when consolidating their debts is using credit again.  Having to take out a consolidation loan is bad enough; having to make that payment as well as the same payments you had before the loan is worse.  If you pay off credit cards with the consolidation loan, cancel them!  If you finally managed to get rid of that overdraft, cancel it!  If you are no longer tied to that payday loan every two weeks, don’t repeat your mistake!

A consolidation loan may be the result of bad spending habits; it is not a solution to them.  It’s important to figure out why you ended up in the financial mess that brought on the consolidation loan so that you can avoid that behaviour in the future.  Book an appointment with one of our certified credit counselors for a free, non-biased assessment of your financial situation.  Sometimes all it takes is a different perspective to give you the focus you need to stay on track and change your financial habits.