Debt Consolidation - Is It A Good Idea?

Is debt consolidation a good idea? Should it be considered as part of personal financial planning?

You can make your own decision once you reach the end of this article.

Proper debt management is the basis of proper personal financial planning . This is essential, whether or not you like it.

"Buy Now, Pay Later" is an attitude that can get a lot of us into financial trouble.

Having debt, especially what is known as consumer debt, is generally a bad idea. This is not debt management. To me, this is actually mortgaging your future. Yes, it's that serious. The rule to follow is - if you cannot afford it, then don't own it.

This is generally prudent personal financial planning.

Generally speaking, it is not a good idea to buy something and then have to pay it in future installments. Not a good idea, because of added interest payments and finance charges. An if we miss a payment, the added interest payments and finance charges are compounded and these add to our financial problems.

By now, you should understand the concept of compound interest. Compound interest works both ways - it can be our friend when it is working FOR us. At the same time, it can turn into a nasty enemy when it is working AGAINST us.

The reality is this - don't ever become an enemy of compound interest. It is a terrible enemy!

Consumer Debt i.e. getting into debt to buy that fancy stereo, or some nice gadget is never a good idea. This kind of debt simply does not figure in proper financial planning.

However for those who have already racked up a certain amount of consumer debt, here is a Debt Consolidation and Reduction Plan to clear your debt.

Assuming you owe three banks the following amounts,

Without going into too much details, the plan is this - try to clear the debt with a higher rate of interest first before going to clearing the debt with the next higher interest.

If that is not possible due to additional finance charges, then it is better to be disciplined and pay up one of the loans (usually the smallest one) as soon as possible. Then once that loan is cleared, use the amount that was applied to the first amount and apply it to the rest of the loans.

Proper debt management requires you to do it, even if you don't like it. However, once you realize you are getting out of debt that much faster, you won't mind the extra discipline to implement the debt management plan.

In any case, be disciplined and stay committed to your debt consolidation and management efforts. Here is another resource on debt management. Do check it out - Living within your means - The easy way.

This is an interesting book and provides useful tools for your debt consolidation and debt management plan.

Now back to our debt management example. Once the $8000 loan (12 instalments) is paid up, the instalment amount orginally used to clear this loan should be applied to the rest of the loans.

By the same token, the next loan of $2000 will be cleared and the total instalment amounts originally used to pay for the $8000 and $2000 loan should be applied to the final $4000 loan.

Essentially, the idea is to not let up once any of the loans is cleared, but to apply the "additional" amounts from the previous loans and apply them to those not yet cleared.

Do this with a vengeance, and you will realise that the loans will reduce on a "compounded" basis and will be paid up much faster than you think! The debt consolidation plan works, because it teaches the power of saving, while allowing you the opportunity to learn the real power of debt.

This is simply using compound interest in our favour. So does that mean we should never go into debt at all? Not really.

Generally speaking, most of us may never have enough money to buy a house if we do not borrow money from the bank. For this reason, this is probably the only big-ticket item that should be financed using debt.

Probably the only other reason to use debt is when you use it for income generation. For example, you may borrow to finance a business which will be income-generating. Do not use debt leverage for consumer products as far as possible.

Some financial planners suggest a debt consolidation loan and many banks offer this. You know the pattern. The bank sends an offer to consolidate all your other loans, often at a seemingly lower interest rate.

This is a form of debt management, but my personal view is that it is generally a bad idea. Here's why.

The debt that you have now gets consolidated and is now spread over a longer period. The payment is now smaller and that generates new cash flow. This may seem like a good idea, but that cash is usually spent and more debt is added.

Without the discipline to utilise the extra cash flow and apply it to reducing the debt, debt consolidation is usually a bad option. Debt consolidation is usually a quick fix and it only postpones the inevitable - the pain of financial rehabilitation.

One way to get out of debt is to have multiple sources of income as part of personal personal financial planning . This certainly beats depending on a salary alone. Check out the resources by engaging the earlier link. I am quite sure you will find some useful information there. Do remember to come back though.

This, however, does not mean you can forget about budgeting and debt management. It simply means financial planning for retirement will be that much more easier.

These resources are meant to help you get out of debt and to enable you to have proper financial planning.

Let's talk about financial goals setting as part of your debt cosolidation and management efforts.