Photo by Dylan Gillis on Unsplash
If you’ve been following along, you may recognize that I’ve been working on a series on the role that financial debt plays in our life. Here are the first two articles in that series:
Three Strategies for Using Debt Responsibly - Read it on Medium, Hive, My Blog
Three Approaches to Paying off Bad Debt - Read it on Medium, Hive, My Blog
In response to the article on paying off bad debt, reader Bozz asked my thoughts on debt consolidation. Here is his comment on that article:
In this article, I will talk specifically about how I feel about debt consolidation.
What is debt consolidation?
Debt consolidation is taking multiple debts and putting them together in a single loan or account. For example, you might have three personal credit cards with balances of $1000, $3000, and $1800. Instead of having to pay three different monthly bills each month, you work with your bank to get a personal consolidation loan - one of the strategies we’ll discussion in the next section of the article - and then have only one monthly payment on the balance of $1000 + $3000 + $1800 - or a total new loan of $5800.
Is debt consolidation good or bad?
This is completely dependent on your situation. Personal finance is, after all, PERSONAL. You need to make the decision that is right for you. As you make the decision, I urge you to think about the following things:
If I consolidate the debts, will it allow me to stop using credit cards/debt? (i.e. Will you stop using your credit cards if you consolidate all the debt in one place.)
If I consolidate the debts, will I save money in interest in the long run?
If I consolidate the debts, will I be able to make the new monthly minimum payment with all of my other obligations?
Am I planning to make a major purchase (home or car) in the next few months that might be impacted negatively by consolidating debt?
Are there other conditions on the consolidated debt that I need to consider?
Types of debt consolidation
PERSONAL LOAN
In some cases, like that of my friend Bozz from the comment above, you can secure a personal loan from your bank to consolidate debts. Let’s keep using our example of the $5800 in credit card debt. Let’s say that those three credit cards have respective interest rates on them of 13.8%, 15.2%, and 21.4%. When you talk with the bank, you learn that you qualify for a personal loan of $5800 at 10.2% interest. In this case, if you can stop using your credit cards (i.e. stop adding to the debt), and pay off the $5800 at this lower interest rate, you will save money in the long run.
PLAY THE BALANCE TRANSFER GAME
I used this option quite well to help me pay off debt - although it DEFINITELY has its downsides which I’ll explain.
Still using our $5800 debt example, you receive a credit card offer from a bank to open a new card with an introductory 0% interest rate that will go to 19.2% in 12 months. You can have a credit limit of $6000 on this card.
The positive of this is that if you use that 0% interest rate to its fullest it feels as if you’re “sticking it” to the credit card companies. And you are. According to recent data published in USA Today, the average American has a little over $3000 in credit card debt. Credit card companies send out those low interest rate offers to entice you to spend more.
Back to our example. You apply for and receive the new card. You are able to transfer all three credit card balances over to this card so it now has the $5800 on it at 0% interest for 12 months. Your 3 minimum monthly payments combined for those 3 cards were $250 and you were already putting another $100 towards those cards. You work through your budget and find another $100 to put on the debt each month for a total of $450 a month going towards the new credit card balance. You pay it off with the balance of your tax refund check and voila - you are once again debt free.
I mentioned downsides. Here are the two I’ve encountered most often.
Any new credit card application (or loan you take out) will create a temporary change - typically reduction - in your credit score. Assuming you continue to use credit responsibly your credit score will come back up. Just make sure you match the timing of this up against any plans to buy a car or a house so your interest rate on those purchases doesn’t suffer.
You’ve got to stop accumulating new debt on your cards and not use this one or you could go from bad to worse when that 19.2% interest rate kicks in in December.
HOME EQUITY LOAN/LINE OF CREDIT
If your home is at a point where it is projected to sell for more than what you currently owe on it, you may qualify for a home equity loan. Home equity lines of credit are another way to use the home you’ve purchased as collateral to help you consolidate debt and pay it off at a lower interest rate. The differences between Home Equity Loans and Home Equity Lines of Credit - often called HELOCs is beyond the scope of this article but they are important differences so make sure if you consider this option you look at both and learn the differences between them.
If you own a home and have equity in it then this is definitely an option to talk about a banker with. The caveat here is that you’ve tied your day to day consumer debt to your home.
DEBT MANAGEMENT PLANS
Last are what my reader Bozz called “those services you see on tv” in his original article comment. I’ve not used these services, but I agree with his comment that those seem “sketch”. This is a definite buyer beware scenario. I know of one person who used one of these services and found it incredibly helpful for getting out of debt about 15 years ago. However, the other friend I know who has shared they used one of these services ended up in a deeper hole than when they started.
If it sounds too good to be true, it probably is. If you’re going to use one of these companies, do your due diligence and research them carefully. Also, read anything carefully before signing it. If you don’t understand something, get a lawyer to look over it.
Also, recognize that you have the right to do the same thing they say they do - call and negotiate with the credit card companies on your behalf. In the article on paying off bad debt (Read it on Medium, Hive, My Blog), I mentioned the Conversation Log tool that I teach in my Facts of Life Course. Calling credit card companies and asking for lower interest rates and payment due dates that align better with your life is a simple fact of doing business when you have credit cards. You can do that yourself.
Is financial coaching right for me?
If figuring out your debt payoff strategy alone is not your thing, then consider working with a financial coach like me. We walk side by side with you through the numbers and the complexity to give you new tools and help you uncover all the good things you already know about making your money work better for you. Schedule a FREE, no obligation, 30 minute consultation today.
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