If the goal is to have fewer loans and lower interest payments, doesn’t it make sense to consolidate loans into one larger loan—by transferring balances to a lower-interest credit card or a home equity loan? The surprising answer is: probably not. It’strue that you want to reduce your debt payments. They’re a big drain on your budget. But the way to do this is by reducing your debt, not just by moving the money around.

If people acted like financial-planning machines, it certainly would make sense to consolidate loans. But people don’t act like machines. When they consolidate loans, most people end up running their debts back up on their other credit cards. So they’re left with the same credit card problems they had before—and now a large consolidated loan on top. Consolidating loans seems to encourage people to build up even bigger debts, rather than helping them reduce their debts.

The two main options for consolidating loans each have serious drawbacks. Many people respond to credit card
marketing pitches that offer special low interest rates on balance transfers. But the low rates are usually for a limited time—generally through the end of the year. After that, the rates go back up to levels that are often as high or higher than the rates on other cards. And while people usually intend to pay that card off before the rate goes up, they rarely do. Also, if they use the card for new purchases, in addition to the balance transfer, they find that the special rate doesn’t really apply. A higher rate applies to new purchases, and payments go to pay down the low-rate balance first, which leaves a growing balance of high-interest debt on what was supposed to be a low-interest card.

Home equity loans really do offer lower interest rates. But there’s a reason for that. A home equity loan is “secured” by the value of your home. If you fall behind in your payments, the lender can force the sale of your home to recover your debt. That’s a serious proposition. A home equity loan is only a sensible option for people who already have their debt under control.