Ask the Experts: Should an Unsecured Personal Loan be used for Debt Consolidation?

The New York Federal Reserve announced that consumer debt in the third quarter of 2012 decreased slightly, an all-around good sign for the economy and the fast-approaching fiscal cliff.

But with the holiday season upon us, that debt is expected to creep back up, as more than half of consumers are expected to use a credit card for their holiday spending, reported myFICO in a recent survey.

For consumers with lingering debts after the holidays, turning to an unsecured personal loan may seem like a good idea: it puts all your debt in one, easy-to-manage payment, and offers unorganized consumers an ideal way to manage their debt throughout the year.

But is a personal loan really necessary to take care of your debt?

The Experts Weigh In: Is a Loan an Effective Debt Solution?

For answers, we turned to three financial professionals, all of whom expressed what an important decision it is to try to manage your debt yourself before turning to any type of consolidation or relief program.

“Personal loans play an important role for those who are trying to get out of debt quickly,” said Greg Meyer, Community Relations Manager of Meriwest Credit Union. “Properly used, they can be an easy way to paying off high interest credit card debt.” But, he warns: “If they are used improperly, they are a fast ticket to a lower credit score” and even further debt.

According to Meyer, the point of a loan for debt consolidation is threefold: to eliminate debt, improve credit scores and create financial plans that can help avoid future debt. Although these are simple enough, it’s borrower irresponsibility that often makes these loans trouble.

“A person can get a consolidation loan, consolidate their debts into a more reasonable and affordable alternative and then go out and acquire more debt,” Meyer said. “This completely defeats the purpose of bill consolidation and puts them on the fast track to a low credit score or worse.”

Meyer suggests looking into balance transfer credit cards that may offer better interest rates and increased flexibility. He warns, however, that intro specials and teaser rates should be examined carefully, and all payments should be made on time to avoid increased interest rates as a penalty.

Looking Past the Convenience

Leslie Tayne, financial attorney and debt advisor, believes that using a personal loan to consolidate debt is “robbing Peter to pay Paul,” or simply a way of shifting your debts without actually making much forward progress on them.

“You are taking your current debt and simply moving it into another form,” Tayne said. “While this can mean less paper bills each month, it does not necessarily present a savings or a good vehicle for achieving your goal of being debt-free.”

Instead, Tayne suggests finding ways to creatively reduce your spending, tighten your budget, and try to tackle your debt before seeking an alternative solution.

“Sometimes a tweak of a budget is all that is needed to become debt-free,” said Tayne.

Seeking Alternatives Before a Personal Loan

Personal finance teacher and Productive Leaders CEO Mary Kelly suggests that an unsecured personal loan for debt consolidation is often more expensive than other loans.

Why? Because lenders that offer these types of loans know exactly why you’re seeking one: because you have debt. From a lender’s point of view, the fact that you’re borrowing while already carrying debt doesn’t make you look like an ideal borrower.

For that reason, interest rates are often higher, and a debt consolidation loan may end up costing you more than it’s worth.

Kelly has simple solutions to consider before a debt loan.

“Call your credit card companies to see, politely, if they’ll give you a lower rate for six months,” Kelly said, “which may give you more time to increase your income and pay down your debt.”

She also suggests refinancing your vehicle, if possible, and to shift that monthly savings to paying down debt. As a last resort, she recommends doing what you can to stay financially lean.

“If you are close to getting a personal consolidation loan, consider living on a ‘needs only’ budget diet for three months,” said Kelly. “You and your family agree to only buy absolute necessities, such as items found in grocery stores. Most people are amazed at how much they can save.”

Taking the Right Debt Approach

Although it can be a helpful way to reduce the number of debts you have, an unsecured loan used to consolidate debt is hardly a cure-all. Before seeking a loan, consider what you can do to decrease your monthly expenses, or find ways to increase your income.

Making small adjustments may save you from taking out a loan and only moving your debts around, not paying them down. But if you do end up getting a consolidation loan, be sure to make timely payments and effectively work your loan into your monthly and yearly budget. 

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