Debt Consolidation and the “Orbital of Stupid”

Yesterday, I heard a very interesting story on NPR that focused on Dave Ramsey looking at Greece’s debt situation through a personal finance lens. Without going into the politics of it, Dave made the astute observation that if a person behaved in the same way that Greece (or any other nation verging on default) behaved, they would be in a deep, deep personal crisis.

The story ended with a very interesting line:

Ramsey says the data from his world of personal financial advice is not encouraging: Most people who consolidate their debt are back in trouble within two years.

This statistic isn’t surprising to me in the least. Zero-interest balance transfers, home equity loans, and the like can go a long way toward turning high interest debt into much more manageable low interest debt.

Most of the time, debt consolidation is used merely to give a person enough breathing room to continue their life as usual. It’s just another way to move around bills in the short term to extend the party a bit.

Of course, some of the time, debt consolidation can be a great tool for getting your house in order.

The difference between the two groups isn’t measured in dollars and cents. It’s measured in whether or not the debtor is actually committed to financial stability or if they just want an easy route to more short term stuff and long term problems.

Here’s the real truth. If you are in a situation where debt consolidation looks appealing to you, it won’t help even a little bit if you don’t get your spending under control. In fact, it’ll probably make things worse over the long run.

To get into that situation, you have to be spending more than you earn. In order to get out of the situation, you have to be spending less than you earn. If you’re not committed to making the changes it takes for that, then you’re just shifting the dirt around to dig yourself a deeper grave without the walls collapsing in on you. You’re reducing the interest rate on some of your debt, which gives you enough monthly cash flow to start racking up more debt, which is completely in accordance with your lifestyle.

Before you consider consolidation, get your spending under control. If you can’t go more than a paycheck or two without spending more than you earn, then debt consolidation will do nothing more than make the long term problem worse for you (simply because it enables you to get into even more debt).

The key is to get your spending under control, not finding a great debt consolidation program. Using debt consolidation as a means to extend your overspending ways is, as Dave puts it so nicely, an “orbital of stupid.”

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  1. Four Pillars says:

    I’d like to see Ramsey’s data for his “statistic”.

    He has a long history of making up fairy tales to support his arguments and I wouldn’t be surprised if this is another example.

  2. hr says:

    I wish Obama and the rest of our legislators read this blog.

  3. Aryn says:

    I’ve heard that statistic (or a similar high number) from several sources. It’s one of the many reasons the housing bubble went so crazy – people borrowed against their home equity to pay off credit cards, but then they ran up credit card debt again within two years. Then it was back to the house to cash out more equity to pay it off.

  4. Robin Crickman says:

    While your and Ramsey’s position is generally valid, I would like to point out that there are
    situations where consolidation to buy time is
    a sensible solution. To give one example: I
    have a relative who is older but not yet 65.
    His health insurance cost has risen from low
    3 figures to nearly 4 figures per month over the
    last few years. He cannot switch providers
    because of health problems and he cannot work
    for the same reason. He will turn 65 in a few
    years and qualify for Medicare with far lower
    premiums (and be able to draw social security).
    So his expenses will drop and his income will
    increase but he has to get through the next few
    years first. Accepting the negative income for
    the short term and seeking a way to keep the
    expense of the debt as low as possible seems like
    a reasonable approach to me as long as the payoff
    of the expenditure is planned for and can be
    completed in a reasonable time frame.

  5. J says:

    I have a friend and a co-worker who have both bought into this “orbital of stupid”. The friend refied and HELOC’d his way into being underwater, and had his mortgage containing not only the house, but also at least two cars and untold amounts of credit card debt. The co-worker essentially bought a minivan with a HELOC because his old one was in such poor shape and he couldn’t pay cash or afford the monthly payments on a car loan. But the family still took an expensive Florida vacation this year and everyone in the family got an iPhone for Christmas.

    I know other people who are using home equity to leverage rental property mortgages, time shares, etc.

    These people are all college-educated “smart people”, too. They probably think that they can smart their way out of a future bind. But the problem is that basic money management is pretty dumb, to the extent that kid that can do subtraction of multiple digit numbers can get the basic idea …. when the numbers go less than zero, you can’t afford it.

  6. Doug says:

    Yep, debt consolidation doesn’t fix the behavioral problems that led to the high debt levels in the first place.

    Look at Greece: The government has no choice but to cut spending; there is no other answer but to change the way that country operates, and there are people protesting those cuts. What do those people think will happen if the government collapses under it’s debt? Personally, I’d love to be able to tell those people “Congratulations, you’ve caused this country to collapse. Enjoy the anarchy.”

  7. Nicole says:

    People are not countries. Countries live forever (or at least developed countries live a lot longer than people do… countries that aren’t stable have a hard time getting credit). People don’t.

    I’m not saying that what Greece is doing is intelligent, but I am saying that you should not expect a country to optimize in the same way we would expect a person to. The functions they are optimizing over are completely different. The timescale of repayment is much longer. Measures of trust (for developed countries) are much stronger. They also have abilities, like inflation and taxation, that people do not have.

    It seems like a simple comparison to make, but just because it feels good doesn’t mean it’s a valid comparison.

  8. Nicole says:

    okay… why is my comment awaiting moderation? Not a single link in it. It isn’t especially long. No dirty words… Just a little bit of economic theory.

    Gah. Are you actively trying to get rid of readers?

  9. aj says:

    Dave, and Trent, are spot on here. Debt consolidation looks like a great fix. I’ve done it twice. The first time I made no changes in my spending, and the consolidation loan did nothing more than free up credit card limits allowing me to double my debt in less than two years. The second time, I consolidated as a means of lowering interest rates in a real and concerted effort to fix my finances. I didn’t close out the zero-balance cards because I didn’t want to hurt my credit ratio, but I did lock them away, never to be used again. I made a real effort to spend less than I earn, and the consolidation helped get me on that path.
    Very good advice, Trent.

  10. Susan says:

    There’s no “Fairy tale” needed to support this theory- because it’s fact. And just because he brought the proportions down to a more comprehensible level doesn’t negate his point.
    Banks, socialism, overgrown unions and pop-culture have been supporting an attitude of entitlement and appeasement for years. It’s time that both individual and leadership stop this dangerous cycle and demand accountability on everyone’s part. BUT, when everyone’s been brainwashed that they “deserve” certain privileges for so long, it’s going to be tough to make the change.

  11. AnnJo says:

    This year the rioting is in Greece, next year it could be in California. Public sector unions have grown so large in membership and power in both places (and many others) that they’ve taken over the budgeting process. When it starts to get hard to tax more, they borrow more, but eventually, as Margaret Thatcher put it, you’re going to run out of other people’s money. Combine that deficiency in “other people’s money” with an attitude of entitlement and rioting makes perfect sense.

  12. James says:

    If you have an iPhone, get a personal finance app.

    I never could be bothered to keep receipts, and type stuff into a spreadsheet later.

    But the convenience factor of the iPhone is just right, I’ve gotten into the habit of logging an expense immediately as I pay for it.

    The difference? Before getting this app, I’d end every month $500-$1000 in overdraft, and the credit card just slowly kept on creeping up.

    The past four months I’ve been in the black at the end of each month, as well as eliminating $6k of debt, and saving $2k.

    All because I know exactly where I stand at all times, impulse buys have pretty much tanked to zero.

    When you see that big fat red number on the screen, it’s a bit hard to sweep under the carpet, and that much easier to be cheap :)

  13. If you are not going to change your mindset and attitude about how money comes into and goes out of your life, debt consolidation is a waste of time.

    I never consolidated my debt, I ran though it with a bulldozer.

    However, it can be an effective tool when combined with a true willingness to get out of debt.

  14. Donna says:

    Good Article, says it all – spend less then you earn.

  15. Kate says:

    Just trying to see if I am out of the “Awaiting moderation” loop that means my comments never get posted.

  16. anne says:

    care one credit counseling helped me. w/ them you don’t borrow money to pay off your debts- you just sign up w/ them and they make proposals to your creditors. they take one monthly payment from you and pay your creditors.

    i was so overwhelmed and disorganized when i started i didn’t even have a handle on everyone i owed money to. so even months and years after i was able to add creditors to my program.

    every month i pay $463 to care one, and they pay everyone i owe money to. i’ll be out of debt, except for our mortgage, by february 2011.

  17. Nicole says:

    Still awaiting moderation.

    Let’s try again but with just a shorter part. Countries aren’t people. People don’t live forever. People can’t raise taxes. People can’t inflate.

  18. K.C. says:

    I interviewed the executive director of a local Consumer Credit Counseling Service office and was surprised to discover that most of her clients merely wanted to get help paying down debts so they could continue charging again. They had no intention of getting out of debt or getting debt under control. They had hit the wall and wanted their credit fixed as quickly and painlessly as possible so they could continue charging. It was a real eye-opener for me.

  19. Nicole says:

    “Your comment is awaiting moderation. Please be patient; it may take a few hours for your comment to be approved. This is merely to ensure that no material offensive to a general audience appears on The Simple Dollar. “

  20. Nicole says:

    how funny… the statement about moderation is now awaiting moderation… apparently the moderation notice is itself offensive

  21. Bridget says:

    Which means you should not bailout people or countries (yes, TARP in the US comes to mind – AIG (the main holding company) should have been allowed to go bankrupt.) Why? Because they don’t suffer the consequences of their actions – they don’t learn that the behavior is one which can bring suffering. They are rewarded for their bad behavior. I saw on another blog a very appropos quote from the 1800’s: “Society has for its element man, who is a free agent; and since man is free, he may choose — since he may choose, he may be mistaken — since he may be mistaken, he may suffer.” Bastiat

  22. Stephan says:

    awsome post, its a shame this isnt the lead story on news websites. These loans shift debt, you save in the short term, but the extra cash definitly makes it very easy to rack up even more debt. so now you have a cosnoldiation loan for old debt, and new credit card debt. its dangerious, and like you said, you have to change your money behavior if you want to get out of debt, just lowering your interest payments wont get you out of debt, but it could give you the window to start the process.

    @bridget- i agree that in a perfect ideal world AIG should have been left to die. but its not, and letting AIG die would have created an even bigger mess than we were in the last 2 years. People who oppose bailouts dont realize just how huge some of thesec ompanies are. If GM went out of business, like some people who opposed bailouts wanted, then hundreds of thousands of people would have lost their jobs, from GM workers, to car dealers, to suppliers, etc etc. Instead of banning bailouts, we need a much better way of regulating companies and the risks they take. If we can stop companies from taking on unnecessary risks in the first place, the companies wouldnt face the problems that our economy faced in late 2008.

    Preferred Financial Services

  23. The root cause of the attachment to material possessions (and hence the debt problem) is a lack of spiritual values, be it a formal religion or spiritual belief system. I find that people who lack spiritual values are usually self-centered and will acquire things they don’t really need to feel better about themselves. On the other hand, I’ve found that those who are truly spiritual are not materialistic at all – they’d rather be donating their time or money to a charity or other worthy cause rather than at a shopping mall.

  24. Rachel says:

    @Toronto Bankruptcy Trustee

    That’s a major overgeneralization, and an unfair one at that. Spirituality doesn’t mean you won’t make bad financial decisions, and a lack of it doesn’t mean you’re self-centered or unhappy with your life.

  25. John @ Loan Consolidation says:

    This article is great and one thing that is quite interesting in debt consolidation is that it gives you more time to pay off your debt while you relax your mind.

  26. John @ Debt Consolidation says:

    Both debt consolidation and loan consolidation are the same and I think is one of the best ways to get out of debt. Is great to be here…

  27. Andrea M says:

    I am new to this site and I wanted to post a comment about my experience with a debt settlement company. I just completed a program with Elite Financial and they saved me over 70% of my debts. Although I have seen my credit score suffer because of the program, that is nothing compared to the amount of stress that has been eased. I saved almost $37,000 over the last 2 years. I’d definitely recommend them to anyone that needs help. here is their website – http://www.efs-debtfree.com

  28. David Brown says:

    Can you borrow your way out of debt? Perhaps not. That’s why debt consolidation is not the right solution for most people. I completely agree that poor spending habits should be corrected first. Otherwise consolidating your debt will not make any sense at all. However, debt consolidation can get you back to your feet if you have a fairly stable and decent income.

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