The lure of debt consolidation is the promise of an “easy fix.”  Companies offering the service advertise things like low interest rates, one low monthly payment, and, with the promise of saving money, it is a lure more and more Americans fall for.  Added to that, flashy slogans and catchy jingles and the debt consolidation business is rife for less-than-honest loaners to take advantage of unwitting consumers.  While not all debt consolidation loans aim to make a quick buck at the consumer’s expense, there are enough in the market to be wary of.

In the last 12 years, the cost of living has soared past the median household income. In addition, the average household has over $15,000 in credit card debt alone and is paying a total of $6,658 in interest per year, or 9% of the average household income. To add to the burden, Americans grossly underestimate the amount of debt they have. In a recent survey (https://www.nerdwallet.com/blog/credit-card-data/average-credit-card-debt-household/), what was reported as estimated debt was 155% lower than the actual debt. It’s no wonder that people are searching for a quick fix.

While a consolidation loan may seem like a way out from drowning in debt without sacrificing much on credit rating, the opposite is actually the case. Applying for these types of loan mean a “hard” inquiry into your credit, this usually will make your score dip a few points. In addition, your credit score is reliant on how much credit you utilize and how many active accounts you are currently paying on time. If all of your credit is maxed out, getting another loan will make your score fall even further, especially if you transfer balances from your other cards and end up close to the limit of your loan.

If a loan is impossible, many people turn to credit counseling companies that offer, for a fee, to work with credit companies and negotiate payment plans and lower interest rates. The legitimate of these companies obtain written agreements from creditors that detail the terms of your agreement, what your obligations are, and what information gets reported to the credit bureaus. In some of these cases, the original creditor may report your account as a bad-debt or a charge-off, which will negatively affect your credit score. Another point to keep in mind is that many of these debt relief companies charge a higher interest rate than your initial rates may have been, or charge up-front or monthly service fees that would offset paying lower interest, so the savings you receive could be nominal.

If you are still considering consolidation to handle your debts, what should you avoid? Many people who resort to debt consolidation do so because they are drowning in debts, usually owing $10,000 or more to their creditors.  One of the biggest mistakes these people make when entering into an agreement for consolidation is to not evaluate the habits that caused the situation in the first place. They may use the loan to cover a majority of debts, only to get another card and max it out. Not only does it end up hurting their credit rating, but, in the long run, only adds to the bills. This money trap has been likened to yo-yo dieting, except with money. In order for the debt relief to actually provide relief, spending habits need to change significantly.

A last resort for many is using a home equity line of credit in order to offset their other loans.  While, given the low interest rates on such loans, it may seem like a good route to go, many don’t realize that they are going from unsecured credit to secured credit, thus putting their house on the line as opposed to just their credit rating. This is an especially dangerous move if the equity in the home is less than 20% at the time of the loan or second mortgage and you can’t afford the additional payment.  With this type of consolidation, if you can’t pay, you risk foreclosure.

So, how can you responsibly pay down your credit without debt consolidation?  The first, most crucial step is to cut down on your expenses.  Take the amount you bring home and subtract what you use each month, whether it be bills for utilities, food, entertainment, credit payments, anything you spend on a regular basis.  Scrutinizing which of these expenses you can cut down on will help your bottom line. If you can open an automatic savings plan to transfer what you’ve saved and pretend it doesn’t exist, even better. Not only will you have cut down your outflow of money, but you will be saving money that you can utilize for future emergencies.

The second step is to evaluate your credit accounts. While common sense may dictate that you would want to pay off the highest balance first, that is not necessarily true. Most financial experts agree that paying off the card with the highest interest rate first is the best course of action. The average credit card interest is approximately 17.41%. If you pay a minimum payment of only $40-$50, the balance can run away from you in a hurry. That means if you have a debt of $1000, at this interest rate, it’s going to take you almost six years to pay it off, provided you don’t add to that debt in the mean time. By paying only the minimum on your lesser-interest debts and applying the maximum amount that you can towards the highest-interest debt, you will reduce the interest that you would have been charged and save money in the long run. Once your highest-interest debt is paid off, you begin applying that same dollar amount plus the minimum payment on the next highest. Keep paying down your accounts until you have nothing to pay off.

While this is the most reliable way to get rid of your high balances, it is also the slowest and many people get discouraged. It is important not to fall into the trap of revolving credit by adding to the cards you are trying to pay down, especially if you are living paycheck to paycheck.

Other factors to keep in mind when paying down your credit are the additional fees that many companies charge. It is imperative that you pay your bills on time to avoid late fees – the federal limit is $25, but many companies skirt the limit by tacking on “processing” fees and increasing the interest rate they charge, even for one late payment. Additional late payments increase the fee to $35. Add to that the possibility of going over your credit limit with these fees, and you’re paying even more.

In the long run, taking responsibility for your debts and handling them yourself is usually the most beneficial route to go. If you have any questions about which debts to pay off first, your CPA can help you by running an amortization schedule to show you what you are actually paying into each account.