To the person drowning in debt, a debt-consolidation loan looks a lot like a lifesaver. But reaching for it without knowing exactly what it's made of could be a serious mistake.



Basically, there are three ways to consolidate:


2. Transferring all of the balances to a new credit card. Beware of excessive transfer fees or accounts that have other troublesome conditions buried in the fine print. The interest on credit cards is always subject to increase, even when it is advertised as a "fixed rate." And if you are looking at a zero-interest introductory offer, know exactly when that expires because if you have a remaining balance it will be subject to a big interest rate.

3. A home-equity loan. It sounds great to pay off your high-interest debts with money borrowed against your home's equity. But this only increases the stakes. Now if you fall behind, the lender takes your home through foreclosure.



I call it the "doubling effect." If you've ever lost 10 pounds and gained back 20, you'll understand right away. Most people who pay off all their pesky credit-card balances look at those zero balances with a sense of personal accomplishment. They've done something remarkable. They didn't really repay their debts -- they just moved them to a new location -- but they enjoy pretending. They say they won't use those accounts again, but they fail to close them. They leave them to "build credit" or to provide cushion -- just in case of emergency.




Are the terms reasonable? If, for example, the new loan or credit card carries significant penalties, such as you lose the attractive interest rate if you are late one or two times, that is not reasonable. If you must pay a big loan origination fee, that is not reasonable.

Am I sufficiently financially mature enough to cancel the accounts that will be paid off in the consolidation process? Only you can answer this. Be honest with yourself.

