Ways to use debt consolidation to reduce your debt
If you added up all your debt, how high is that number? And do you think it’s more or less than say, your best friend’s? Or maybe your boss’s? According to the 2016 American Household Credit Card Debt Study, the average household has racked up a whopping $135,924 in debt. Yeah, a big chunk of that is your outstanding mortgage, but it also includes an average credit card debt of $16,425. Did you know that the interest alone on a revolving credit balance of that caliber could cost you almost $1,300 per year– how crazy is that?
The cost of debt
We all know that debt doesn’t only come in the form of credit cards. It includes student loans, mortgages, car payments, medical payments, personal loans, and any other type of money borrowing or payment plan arrangements. All debt, however, is not created equal. While subsidized student loans might be 6.8%, unsubsidized loans could be as low as 3.76%. Compare that to credit card debt at 15% – 18% or more. An auto loan might be 5%, and a mortgage could cost around 4%.
If there is a type of “good” debt, it would be low interest and definitely used to finance something that will provide value in the future, e.g., your education or a home. “Bad” debt, on the other hand, is high interest, used to purchase an item that has no long-term value or is beyond your income level, e.g., revolving credit card debt, ridiculously expensive designer clothes or a car with a monthly payment that eats up the majority of your paycheck.
What is debt consolidation?
Debt management is a serious issue and a growing concern for many Americans. We all want to honor our financial commitments, but how can we handle outstanding debt and manage it more responsibly? Debt consolidation is the act of combining multiple outstanding debt contracts. It allows you to repay multiple creditors at one time and to consolidate multiple monthly payments into one new monthly payment paid to one new loan issuer. Ideally, it should reduce your interest burden and the overall long-term cost of your debt.
Ways to consolidate your debt
If managing your outstanding debt has become too much of a challenge, as it has for many people, there are several solutions that may help you consolidate your payments, save some interest, and salvage your credit at the same time.
Debt consolidation can be a bit risky from both sides of the coin, however. Borrowing funds to satisfy your current creditors addresses one issue, but how easy is it to fall back into your old habits? It’s a serious matter for both you and any financial institution to consider. You may be confident that you’re on the path to debt-free living, but your potential loan issuer may or may not be willing to take on that risk. It’s a common reason for any potential solution to be declined, so be prepared. There are both pros and cons to each approach, so it’s critical to understand what’s at risk when it comes to choosing an option.
1. A zero interest credit card
Credit cards and revolving debt and can be double trouble if you’re trying to consolidate debt, but if you can find one with zero-percent interest, you may be able to take advantage of that introductory rate for six months to a year. Zero-rate cards target high credit score consumers, so they’re a little harder to come by. If you qualify, be sure to check the fine print for transfer fees, penalties for late payments and any other hidden charges. Consider transferring only the amount you can pay off before the rate expiration because when it does, it will likely jump to a much higher rate. If you transfer more than you can pay off, be diligent about searching for another card to transfer the balance before the rate expires. Remember, too, that opening too many new credit card accounts within a given period of time may negatively impact your credit score.
2. A home equity loan or line of credit
Do you own a home? One of the most popular ways to consolidate debt is through a home equity loan or line of credit. By borrowing against your home, you’re able to withdraw cash that can be used to pay bills that are incurring higher interest charges. You may also get a tax break, too. Be careful, though. Default on the loan and you could lose your house. And be sure to talk with your tax advisor before pulling the trigger. Equity loan interest tax deductions could be limited in some instances.
3. A debt consolidation loan
Using a debt consolidation loan to pay off your debt increases your bill paying efficiency, saves your hard-earned money from excessive interest charges, and simplifies your overall life all in one fell swoop. With 15 different creditors, each with a different interest rate and payments due on different dates, who can keep track? With a debt consolidation loan, simply pay them all off and repay one new loan. It’s one single payment on one day of the month. Easy? Yes. Does it always add up to savings? No. Make sure you do the math. You also don’t have anything to secure the loan, like a house, so it’s likely that the lender might bump up the rate just a bit, understandably so. Be sure to do your homework and shop around.
4. A loan from a friend or family member
One final way to consolidate your debt is to borrow the funds from friends or family and design a repayment plan that agreeable to both of you. There are many variables involved in this type of arrangement, including being comfortable enough in your relationship to be able to ask for and repay a significant amount of money. You must also be willing to share the full details of your current financial standing, your plan for budgeting future spending and expenses and how you envision a structured repayment plan will work. Although borrowing money from family and friends may be easier and often less expensive from that of a bank or other financial institution, it also comes with significant risks. Money often changes relationships, especially when one party feels that the other oversteps their bounds or doesn’t honor the agreement. Choose wisely and weigh all of your options. Otherwise, strained relationships may lead to very awkward holiday conversation.
The main objective of debt consolidation is to get to a point where you’re comfortable with a monthly payment that effectively reduces your debt in a reasonable amount of time. Yes, debt consolidation can help you pay off debt faster and help you avoid credit damage, but it also requires discipline and sacrifice. If you’re ready to address your concerns with debt management, talk with your financial professional to design a plan and implement a solution that works for you and your wallet.