Credit card debt among Americans is at an all-time high.
When facing such massive amounts of debt, it may be tempting to consider consolidation, one of the most popular ways for consumers to cope with mountains of bills. But before making such a move, it’s important to think about the potential downsides and drawbacks—and there are quite a few.
“Debt consolidation is rarely a good option,” says Holly Morphew, a certified financial health counselor. “Those looking to consolidate debt usually don’t understand what it is and are simply stressed about unmanageable debt and looking for a way out of it.”
Among the nuances to understand is how consolidation impacts your credit score, what your new interest rate will be, and what the repayment terms are—particularly when consolidating student loan debt, which can be dangerous, says Morphew.
Here are six of the biggest drawbacks to keep in mind when considering debt consolidation.
1. Transfer Fees
Consolidating credit card debt via a balance transfer to a new card can seem enticing, especially when there are so many 0% APR offers being presented to you at every turn. But Han Chang, cofounder of InvestmentZen.com, warns that nothing is ever free.
“Offers like this usually come with a one-time balance transfer fee ranging from 3% to 10% of the total balance transfer,” says Chang. “That can really add up and, if you’re not careful, completely negate any savings that 0% APR offers.”
2. Government-Backed Program Losses
Another often-overlooked drawback of debt consolidation is the potential loss of government-backed programs, primarily pertaining to student loans. While there can definitely be some advantages to combining all of your student loans, be sure to read the fine print of your new agreement carefully.
In particular, determine whether you’ll still be eligible for common federal government perks.
Morphew says student debt consolidation is actually one of the most risky things to do.
“If you don’t choose the right company, or decide to consolidate federal subsidized loans into a private loan, you can lose those repayment benefits such as deferment, forbearance, and loan forgiveness,” she says.
3. Credit Score Dings
If you are working with a debt consolidation company or a financial institution to combine your bills, the company will likely conduct a hard credit inquiry. While the effects of this inquiry are temporary, says Chang, be prepared to see your credit score drop in the short term.
“If multiple creditors pull reports, your score could drop significantly,” he adds. You can keep an eye on your credit score by reviewing your credit report for free on Credit.com.
4. Unchanged or Increased Interest Rates
Often the goal of debt consolidation is to secure a lower overall interest rate. But that’s not always what happens, says Morphew. You can actually end up paying more because the company giving you the new consolidated loan will average the rates on your debt and round up based on its terms, she says.
In addition, if you have poor credit to begin with, you may not qualify for a lower interest rate, says Amber Westover of BestCompany.com.
“You may end up paying more for your debt over the course of your consolidation loan,” Westover says.
5. Expensive Debt Consolidation Costs
Debt consolidation companies don’t work for free. Many national companies offering this type of service charge a fee of 15% of the total debt, says Richard Symmes, a consumer bankruptcy attorney.
“This leads the consumer to pay much more than if they had negotiated with the creditor on their own. Many of these fees may even be fraudulent under individual state laws, which cap how much a company can charge for debt consolidation services,” he says. He instead suggests conducting such negotiations with the help of an attorney, who simply charges a flat fee.
6. Increased Overall Loan Costs
One last drawback worth noting: just because your monthly payments may go down under a debt consolidation program doesn’t necessarily mean your overall debt is going down.
“If you consolidate high-interest short-term debt for very long-term debt, then you may actually be paying more,” says financial analyst Jeff White. “For instance, paying $500 per month for one year (which translates into $6,000) is less than paying $75 per month for 10 years (which is $9,000).”
Consolidating could be a smart financial move, or it may just sound like it. To find out if consolidation or another debt management strategy is right for you, visit our Managing Debt Learning Center.