What is debt consolidation? And is it right for you?

SAN FRANCISCO (KGO) -- Paying off debt is a New Year's resolution for many people.

But if you cannot afford to pay it down, is debt consolidation right for you?

7 On Your Side's Michael Finney spoke to Dr. David Yeske, a Financial Planner and Distinguished Adjunct Professor at Golden Gate University in San Francisco.

In an email to 7 On Your Side, Dr. Yeske provided additional information on debt consolidation.

Debt consolidation is the process of "consolidating" numerous debts into a single loan with a single payment. Ideally, the payment would be lower, but most importantly, you want to have a lower interest rate than the rates on the loans (including credit card balances) that are being paid off. Bringing your obligations together under a single payment at a lower rate of interest means that you can retire the debt faster and at lower total interest cost.

The simplest example of this is transferring one or more credit card balances to a credit card offering a promotional zero-interest balance transfer offer. Since credit cards charge interest rates as high as 30%, transferring your balance to a zero-interest card means that the same payment retires principal at a much faster rate.

Banks and other financial institutions also offer personal loans that can be used to consolidate other loans - credit cards, car loans, student loans, etc. - at varying rates, depending on your credit score. This brings up an important point: the ability to make this work will, to some degree, be dependent on your credit score, those with high scores will be offered low rates and those with low scores will be offered high rates, or not qualify for a loan at all.

It's important to look at the rate you're paying on a consolidation loan, not just the payment. In some cases, the consolidation loan may have a higher rate than the debts being paid off but a lower payment because the loan is being amortized over a much longer period. What this means is that, while one's budget may look a little better in the short run, it will take much longer and cost much more interest to retire the debt.

Another potential pitfall involves spending behavior. If one has run up a bunch of expensive debt because of a one-off event, like a medical emergency, then consolidation is a good solution. If, however, debt is out of control because of poor spending behavior, the risk is that one transfers all the credit card balances to a personal loan and then runs up the credit cards all over again. At this point, you've simply doubled your debt load and are far worse off than when you began. So, if someone has gotten in over their heads because of poor spending habits, they should consider consulting with a credit counselor or CFP who can help them understand and modify their spending behavior to be much more sustainable.

For those who are in over their heads and don't qualify for a low-interest personal loan or zero-interest promotional credit card offer, debt restructuring may be the only option. This is a process where the individual works with a credit counseling agency to negotiate lower rates and a fixed (structured) repayment plan to get the cards paid off. Often, this takes the form of a single payment made to the restructuring firm or agency, which in turn pays the credit card companies. One consequence of this approach is that your credit card accounts will all be closed. This can be inconvenient but avoids the trap of transferring balances and then just running them up again. This is the option for those who don't qualify for any consolidation options but would like to avoid bankruptcy.

When seeking help from a credit counseling office, one should seek out only the non-profits.


Watch the video above to see the entire interview.

Take a look at more stories by Michael Finney and 7 On Your Side.

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