Debt Consolidation

Debt consolidation makes it easier to manage multiple unsecured debts by combining them into one unsecured loan. The types of debts normally consolidated include credit card, charge card, and retail card balances, lines of credit, and medical bills. Debt consolidation loans are provided by banks, credit unions, and other reputable lenders. However, debt consolidation can be risky and costly, so understanding the type of loan you’re getting, its interest rate and term, and other important factors is essential to ensuring the loan serves a positive purpose. If you habitually spend on your credit or charge cards, this loan may not be a good choice for you given that you may be tempted to once again spend against your freshly paid credit lines.

Effectively using debt consolidation to improve your financial health and credit score is once again about personal and family choice and discipline. There is no point in clearing all of your high interest credit card debt using a new loan if you’re going to go back to spending on those same credit cards again. You need to change your personal and family spending habits if you’re truly interested in addressing your debt. So, while it’s nice to say that you only have one loan to make payment on every month, you’ll soon be back to making multiple payments if you revert back to your old ways.

How do you change your habits? Start evaluating every purchase you make. Even as you’re taking items off the grocery store shelf, you should be considering whether or not you really need the item. Do you really need two bags of chips instead of one? Do you need that chocolate bar or pint of ice cream? Do your kids need three bags of candy? Do fast food oven meals cost more than the meals that you take the time to prepare? Does anyone’s waistline really need any of the above? This "critical thinking" is a starting point for shaping your broader financial habits, as these small actions will lead you to begin questioning every single purchase you make. This becomes very useful throughout life as you evaluate what car drive, whether or not you buy a boat, or if you go on a dream vacation.

As you make decisions not to spend, record them in a notebook or using a smartphone application like Evernote. Or, signup for a subscription from a service like TrueBill that links your cards and tracks your spending habits on a daily, weekly, and monthly basis and compares them with previous results. The great part about TrueBill is that the application emails your results to you on a frequency of your choosing. If using a notebook or note-taking application, take note of the date of the decision, the type of item you were going to buy (and, potentially put back on the shelf), and the value of the item. At the end of each week, add up the total of your decisions not to spend. At the end of the month, add up the weekly totals. You will likely be floored by how much you saved over the month as a result of not impulse buying according to your normal daily wants.

And, this is the point: Wants versus needs. Needs are the things that you need to survive. That doesn’t include just food, water, shelter, your utilities, your car, gas, etc. Needs can also include reasonable weekly social interactions, date nights to keep things good with your partner, and maybe a beach or lake trip a couple of times a month. Wants are all the silly things we spend money on such as makeup that will be used once, jewelry you never wear, three extra bags of candy for your kids, or that pint of ice cream. Be disciplined, control your spending, and you will be out of debt sooner than you think.

Getting back to debt consolidation: We now know that if you’re disciplined, these types of loans can be a good thing. However, you need to fully understand the terms of the loan in order for it to make sense for you. In many cases, debt consolidation loans can be attractive because the lender says “the loan term will be 5 years now and your monthly payment has dropped to $500 including interest and fees per month.” This might sound great from the outset since you’re paying over $1000 a month across your bills right now. So, it’s important to do the simple mathematics. If you continued paying $1000 a month right now, how long would it take for you to get out of debt? And, how much of the $1000 is actually interest and fees? For the new loan, you’re now committed to 5 years at $500/month with prepayment penalties (yes, you can be penalized for paying a debt consolidation loan early!). Let’s hypothesize that at a $1000/month you can be debt-free in 2 years, which is $24,000 in payments. But, with the consolidation loan you’re paying $30,000 over 5 years. You’re essentially paying $6000 more for the convenience of a lower monthly payment, and the majority of this is likely going to lender interest and fees. The best way to calculate this is in table form, lining up your debt side-by-side and truly evaluating what makes sense, and not impulse buying a new loan because it’s shiny and new!

Debt consolidation loans are generally easy to get if you have a decent credit score, a low number of inquiries on your credit account, and stable employment and income history. Most lenders, including your own bank, understand the benefits of debt consolidation if they can see demonstrated consistency in your financial management. However, if you have a poor credit score and have a history of living paycheck to paycheck, it’s likely you’re going to have to explain to the Loan Manager how you’re going to change your spending habits and even offer to close some of the credit accounts the new loan will clear. Any responsible lender should strive to help you improve your overall financial health and credit score, even if it means being a bit tough with you during the loan approval process.

Alternative lending options including Peer to Peer (P2P) and other online lenders. These platforms connect people with money to lend with those who need to borrow it. You can wholly expect that you’re going to pay a much higher Annual Percentage Rate (APR) with these lenders, so shop around before committing to a loan. People with less-than-perfect or low credit can expect that P2P and online lenders will be more willing to lend to them. But, again, this will come with additional interest and fees to offset the risk of default. However, if you’re diligent with making your monthly payment on time every month and never miss a payment, there’s the possibility that your credit score will improve over time and you’ll be able to refinance your loan with your bank in the future.

If you do face an emergency that may require you to run up a significant amount of debt on your credit cards and other lines of credit, evaluate your options before you do so. Many lenders have loans tailored towards emergency situations like repairing the roof of your home or paying for medical bills that your insurance company doesn’t cover. Some of these lenders also have a 24-hour approval process, meaning that you can have the funds in your account within a day. This means that you can take out a short notice and potentially short-term loan with a lower interest rate instead of accruing the debt on your high interest credit cards. Not to mention managing this debt would be much easier than paying down multiple cards over time.

Tip 1: Change your spending habits. That is the only way that you’ll fully achieve financial freedom in the future. Nobody wants to spend their entire life under the burden of heavy financial debt. Living like this can affect your health, your family, and everyone else around you. When you’re in debt, it’s important to evaluate every decision you make. Sometimes that is as simple as deciding to stay home on a night that everyone else is going out and saving the money you would have otherwise spent. Instead, go to the gym, go for a walk, enjoy nature, get some fresh air, or even just catch a movie on the couch. You will feel better the next morning because (1) you probably saved a lot of money and (2) you might have missed the hangover that everyone else has the next day. It is really these simple decisions that make the biggest difference when you look at what you spend at the end of every month. Again, you will be very surprised by how much you save if you start moderating your own behaviors and take a conscious step forward in resolving your debts. Yes, a debt consolidation loan can help you immediately solve the complicated process of managing and paying your monthly bills. But, if you end up with the same debt as before plus the debt consolidation loan, what was the point?

Tip 2: You really shouldn’t have more than two open credit cards at any time. If you prefer American Express, get a low limit charge card or one of their air miles cards. Given that a lot of places don’t take Amex, get a Visa or MasterCard as well. Again, a card with cash rewards or travel rewards is preferable so you can earn for every dollar you spend. Stay away from retail credit and charge cards if at all possible. They carry very high interest rates.