Serial debt consolidation: The road to financial ruin


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People often try to deal with mounting debt and credit problems by doing a debt consolidation. In theory, it’s a sound idea. But in reality, one debt consolidation leads to another, and then to another. It’s called serial debt consolidation, and it’s more often the road to financial ruin then to credit salvation.

How does serial debt consolidation come about?

The humble beginnings of debt consolidation

The debt consolidation treadmill usually starts almost unnoticed. You get one credit card, then a second, then a third, and before you know it you have balances on all three. Not to worry, you can “fix” this in a hurry with an informal debt consolidation process that goes something like this:

Credit cards. This is usually the first step in serial debt consolidation. You get a 0% balance transfer offer from a credit card company, and proceed to “pay off” your other credit cards. With all of your credit card debt conveniently located on a single credit line, with one monthly payment, your credit card debt looks incredibly manageable.

Formal debt consolidation loans. Once you consolidate credit card balances on a single large credit line, the temptation is enormous to begin spending money using the older credit cards that now have no balance. Soon enough you’re up to four credit cards with balances, one with the initial consolidation, plus the original three.

At that point you’re probably looking for a true debt consolidation loan. It may be a fixed rate loan that will be paid off in a specific amount of time, say five years. These loans are typically unsecured, and often acquired through your personal bank, or on peer-to-peer lending sites, like Lending Club and Prosper. It seems like the smart thing to do, and it is – if you could stop using your credit cards.

But you don’t.

Debt consolidations secured by your house. You now have the debt consolidation loan, plus balances on virtually every credit card that you own – again. The debt level is getting scary, and the combined payments are becoming increasingly unmanageable. But you have one more option: your home.

You do a debt consolidation, either by taking a home equity line of credit (HELOC) or by taking a new cash-out mortgage on your home. Because the equity is stripped out of your home, you promise yourself that this will be your last debt consolidation, and the end of your love affair with credit cards.

But it isn’t.

You have become a serial debt consolidator, and soon enough you will run up the balances on your credit cards again, and soon enough you’ll be looking to do yet another debt consolidation.

Debt consolidation doesn’t lower your debt – only your monthly payment

The most basic problem with debt consolidation is that it doesn’t do anything to lower the amount of money that you owe. All it does is lower your monthly payment. That might make your debt easier to live with, but it doesn’t do much to pay down the balance.

The long-term trend is that you always owe more money – on your credit cards, on debt consolidation loans, and through mortgage indebtedness on your home.

Even though your income may grow over the years, your debt level – and the associated monthly debt service payments – continues to rise, and often outpaces the growth in your income.

Debt consolidation clears the path to new debt

One of the scarier side effects of debt consolidation loans is that they actually make it possible for you to go even deeper into debt. After all, once you consolidate three or four credit card balances into a single debt consolidation loan, you now have open balances on all of those credit cards that you can use for future purchases.

Compounding the problem is the “moral hazard”. Because you have successfully managed ever higher levels of debt over the years, you begin to believe that there is no end to the process. Each debt consolidation emboldens you take on a fresh wave of credit, and the process goes on.

In this kind of situation, the debt consolidation not only fails to lower your debt level, but it actually works to increase it. Your debt level increases because it can!

The day of reckoning is postponed for years & your debt grows

Many people are able to continue to be superficially solvent for many years using serial debt consolidations. They may even have outstanding credit scores as a result. After all, each time you pay off your credit card balances, your credit utilization ratio drops, which causes your credit score to rise.

And as it does, you get more credit card offers in the mail, and often at rates that are too good to pass up.

But credit scores only measure debt management; they don’t account for income in any way. It’s entirely possible that your serial debt consolidations quietly enable you to acquire more debt than your income can handle.

Maxing out your credit even with debt consolidation

It may seem that you can continue doing debt consolidations, as evidenced by the fact that you have been successful in doing them for many years. But sooner or later you will reach your own debt ceiling – the point at which you are no longer able to obtain additional credit.

This can happen when your income no longer supports an increasing level of debt. It can also happen when you’ve completely stripped the equity out of your home. And when your credit card account balances are completely maxed out. Worse, all three of these conditions can – and often do – happen at roughly the same time.

And when it does, you sink into…

The debt consolidation crash & burn

At that point, you are unable to get new credit. And since you have basically been using new credit to pay for old loans, the loss of new credit creates a crisis. Loan payments become sporadic, your credit score drops, and the problem is compounded. You’re now considered to be a bad credit risk, and some lenders may start attempting to call in their loans.

Some form of default becomes inevitable, even if you have been maintaining the debt consolidation process for decades. If you are maxed out on all fronts, and your income is no longer sufficient to pay all of your debts, you’ll have to take drastic action.

That may involve debt settlement, credit repair, or even bankruptcy. If you reach that point, you’ll need the services of a law firm that specializes in these areas.

That’s a step that you will need to take as soon as possible. Being stuck in the grip of a credit crisis is never a position you want to stay in too long. Not only are there few good options, but the situation usually goes from bad to worse – and in a real hurry.

Bottom line? Debt consolidation is a very dangerous trap. You might consider using this technique one time. But only if you take drastic steps to eliminate the core problems; spending and debt. Debt consolidation addresses neither – and that’s why it’s so dangerous.

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Featured Image Credit: Sezeryadigar/istockphoto.