Debt Consolidation: A Sensitivity Analysis

Moon, Kenneth P.; McClatchey, Christine A.
December 2005
Journal of Financial Planning;Dec2005, Vol. 18 Issue 12, p60
Academic Journal
• The decision to refinance an existing loan or consolidate several existing debts into one loan is not as straightforward as many consumers believe. Many consumers fall prey to lender advertisements by assuming that the correct analysis is to compare their current monthly obligations with that of the loan consolidation. • Research in the area, and general financial theory, suggest that consumers need to consider all relevant cash flows, on a present value basis, associated with the decision. Consumers often have multiple debt obligations that complicate the analysis because not all obligations follow a simple annuity amortization schedule. Additionally, the client's obligations may differ in their maturity, interest rate, and tax deductibility. Hence, a simple breakeven analysis may not be warranted. • Previous research has generally focused on simply refinancing one's existing mortgage and determining the "optimal" time it takes to recover the cost of refinancing, without providing a basis for including other existing obligations. But it is more appropriate to examine the total benefit derived from such a debt consolidation. This article expands the research by providing a sensitivity analysis of the consolidation decision using several key input variables. • The results show that it is difficult to generalize as to what new loan structure is best. Consumers with seemingly similar existing debt obligations may not reap equal benefits from the same loan consolidation structure, depending on the nature of their existing obligations and their repayment habits.


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