3 dangers of debt consolidation

Senior Producer/Reporter
Yahoo Finance

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As we’ve been reading all of your emails, many of you have asked whether or not you should consolidate your debt. When you’re falling behind on payments and struggling to pay off multiple balances on high-interest credit cards, it’s good to explore what your options are and debt consolidation might be one of them. But many experts warn about the dangers to this method and say it should be your very last resort.

Consider every other option first

“I would first investigate all other avenues, including meeting with a chapter of Consumer Credit Counseling Services (CCCS), which is a non-profit organization,” says Barbara Ginty a certified financial planner and founder of Planancial. Before pursuing debt consolidation, it’s a good idea to get a neutral second opinion from a financial advisor or debt counselor, she says.

Julie Ford, a certified financial planner and founder of Ford Financial Solutions, echoes Ginty’s advice. In her experience working with clients, she’s never recommended debt consolidation because she’s always been able to find another, more cost-effective solution like calling your existing creditors directly to work out a payment plan. “Sometimes debt consolidation and signing up for lower interest rate credit cards can be like hacking away at branches and not getting to the root of your problem,” says Ford referencing Carl Richard’s New York Times article about paying attention to get to the source of your spending problem.

The fees and extra interest payments can make it a bad deal

Both Ginty and Ford advise their clients to beware of how much they’d be spending over the life of the process, because you could easily end up being in more debt if it’s not handled properly. Sure, a debt consolidation company can entice you with their promise of lower monthly payments, but they do this by stretching out the length of time you’re making those payments. Not to mention fees associated with consolidation: companies will typically charge a percentage of the original debt amount as well as fees based on how much debt they settle for you.

Unlike government-approved non-profit credit counseling services, debt-consolidation companies are making money off of you and it can be a slippery slope — especially when you’re being targeted by these companies, Ginty said during our credit card debt Q&A.

If debt is forgiven, it’s almost always taxable

If a portion of your debt is settled, keep in mind that any debt that’s forgiven will be treated as taxable income. These types of financial hits can come unexpectedly if the consolidators haven’t clearly communicated all the ramifications of your decision.

“Do your research about who you’re working with. If you have a gut feeling it’s not right, you’re probably right and need to move on,” says debt attorney Leslie Tayne. Make sure you’re working with a reputable company who’s been in business for a long time, with consumers that are satisfied with their services, says Tayne.

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