Debt Consolidation: Avoiding Common Pitfalls & Protecting Your Finances

You've vowed to eliminate your credit card debt, but your bills are too overwhelming. You're ready to consider a final option: debt consolidation.

It's true that consolidating your debts can make it easier to eliminate them. But debt consolidation can come with its own financial traps. Because of these potential pitfalls, consumers should be wary before signing up for debt consolidation. Bruce McClary, vice president of external affairs and public relations for the Washington D.C.-based National Foundation for Credit Counseling, says that sometimes, it makes more sense to consider other options.

"Debt consolidation is not always the right choice," McClary explains. "It is not a free service. And often, you can take care of your debt on your own, if you change your spending habits and take a more disciplined approach to paying off your existing debt." (See also: 5 Tricks to Consolidating Your Debt and Saving Money)

Here are the most common debt consolidation traps to avoid.

1. A Sky-High Interest Rate

In debt consolidation, a company will combine your debts into one single monthly payment that you can afford. In theory, it's a low-stress way to tackle what would otherwise be overwhelming.

But even if your monthly payment is lower, this doesn't mean that you won't be spending too much. Some debt consolidation companies charge high interest rates to go along with the new monthly payment plans they set up for their clients. Make sure you ask your debt consolidation company what interest rate they'll charge you. If it seems too high, look elsewhere.

2. High Fees

Debt consolidation isn't free. But some debt consolidation firms soak their clients with especially high fees, either in the form of monthly or upfront charges.

Again, make sure you know exactly what fees your debt consolidation company plans to charge you. Request a list of these fees in writing so that there's no confusion. If the firm won't provide this information to you, don't work with it. You want to work with a company that is clear about how much it charges.

3. Consolidating the Wrong Debt

Some forms of debt are worse than others. Credit card debt with high interest rates, for instance, is the bad kind of debt. But debts with low interest rates, such as auto loans or student loans, are generally considered good debt.

You might be tempted to consolidate all of your debts into a single monthly payment. But rolling low-interest-rate debts into your monthly payment might be a poor financial decision depending on the interest rate of your new debt consolidation loan.

When taking out a debt consolidation loan, focus on your debts with the highest interest rates. Pay off your low-interest-rate debt on your own.

4. Running Up Your Debt Again

Taking out one debt consolidation loan is bad enough. But if you don't change your spending habits, you might find yourself facing overwhelming debt again, even after paying off a debt consolidation loan.

Consolidating your debt is treating the results of your bad spending habits. This isn't the same as treating the reasons for your bad spending.

Once you've entered debt consolidation, it's time to determine why you ran up your debt in the first place. Maybe you spend when you are anxious. Maybe you overspend in an effort to keep up with your neighbors. Maybe you've never learned how to make and stick to a budget. If you don't address the reasons behind your overspending, you run the real risk of piling up debt yet again.

Have you tried debt consolidation to eliminate debt? Did it work?