By consumer credit expert Gerri Detweiler, author of
Slash Your Debt, Save Money & Secure Your Future and a new website,
DebtConsolidationRX.com.
Next to winning the lottery, a debt consolidation loan is
a debtor’s dream. With one monthly payment and a fixed monthly payment schedule,
you can actually see an end to those monthly payments.
In reality, consolidating bills isn’t always easy.
If you have a lot of debt, it can be hard to find a consolidation loan at
a lower interest rate. And if you’re not careful, you can end up deeper in
debt than when you started.
Your goal in consolidating your debt should be to
lower your overall costs. To accomplish this there are two things
to keep in mind:
1. Get the lowest interest rate possible
2. Have a plan to pay off your debts in 3 – 5 years.
Here are some of the best ways to consolidate:
Using Credit Cards
The good news about this method is that with a good credit rating, you may
get a much lower rate than other forms of consolidation loans.
And since credit card issuers don’t require collateral, you aren’t “risking
the farm.”
Call your current issuer to ask what interest rates they will offer you if
you transfer balances from other cards over to theirs. Go for a fixed rate
if you can get it, and ask them to waive any transfer fees. If you can’t negotiate
a low rate with your current issuer, try shopping for a new card at a site
such as CardRatings.com. But be careful! Too many applications for
credit in a short period of time can hurt your credit rating.
Once you do consolidate this way, be sure to set up an optimal payment plan
so you can be debt-free in 3 – 5 years.
Home Equity Loans
With a home equity loan, you borrow against the value of you home, minus any
other mortgages.
The two major kinds are:
-
A Home Equity Loan – a fixed amount of money for a fixed
period of time (sometimes at a fixed rate)
-
A “Home Equity Line of Credit” where you borrow up to a
pre-approved credit limit (interest rates usually variable) and can borrow
again if you still have money available.
These loans can offer attractive rates, low payments, and
the interest is usually tax-deductible if you itemize. Many issuers offer
no or low closing costs for these loans. Interest rates are often variable,
however, and there’s always the risk that you can lose your home
if you can’t pay.
Cash Out Refinance
Refinancing your home and taking out money to pay off bills (called “cash-out
refinance”) is yet another way to tap the equity in your home. If you can
refinance at a substantially lower interest rate, you’ll eliminate
the high interest costs of the debts you pay off, and you could even
come out with a lower payment than you have right now since rates are so low.
One option to consider: an interest-only loan. By lowering your monthly payment,
you can free up money to use toward paying down other high-rate debt or building
a retirement fund.
Make sure you understand the total cost of refinancing. Take any money you’ve
freed up by paying off other bills and use that to create an emergency savings
fund.
Traditional Debt Consolidation Loans
A debt consolidation loan is an unsecured personal loan, and the only collateral
you are offering for the lender’s security is you. Because lenders consider
them risky loans, they’re usually more expensive and not always easy
to get if you have a lot of debt.
If the interest rate is too high to make it worth it and the repayment term
is ten or fifteen years, you should probably consider another method of consolidation.
However, if the term and interest rate are right, this can be a great way
to actually save money in the end. (Check Bankrate.com for current averages).
Remember, to calculate the total cost of the loan from start to pay-off.
Credit Counseling
Credit counseling agencies may help you get out of debt, though they don’t
actually consolidate your debt. Instead, payment plans (usually with lower
interest and fees) will be worked out for all of your eligible debts. You’ll
make one monthly payment to the counseling agency, which will pay all your
creditors.
Participating in a credit counseling program generally won’t hurt your credit
rating, and if you stick to the plan you can be out of debt in three to six
years. But be careful which agency you work with. If the
counseling agency pays your bills late, you’ll pay the price since you’re
still responsible to the lender. It happens.
Debt Settlement
Debt settlement is another option that’s become increasingly popular with
consumers who have a lot of debt and can’t, or won’t, file bankruptcy. You
stop paying your bills and instead make a regular monthly payment to the settlement
company. Your creditors contact them, and not you, about your overdue bills.
As your accounts fall further behind, the negotiation company will settle
your balances – usually for 50% of the balance or less (including fees) depending
on the debt. Most people can be out of debt in less than two years
or less using these programs.
It’s not perfect. Your credit rating will be hurt in the short run and you
must be certain you’re dealing with a reputable company or the money you pay
each month could disappear. Still, for consumers who can’t shoulder the burden
of debt they have now, it can be a very good option.
Retirement Loans
If you have a 401(k), 403(b) plan or certain types of pension plans, you can
borrow against your nest egg. (You can’t borrow against your IRA.) It’s easy,
with no income qualifications or credit check.
The key here is to borrow against your retirement account, rather than withdraw
from it early so that you don’t end up paying taxes and a 10% penalty. Also,
if you leave or lose your job, you may have to pay your loan back immediately
or pay taxes and penalties for an early withdrawal.
These loans typically offer low interest rates, and interest is paid to you,
since you are the lender. While tapping your nest egg like this can
short-change your retirement, so can costly debt payments.
If you are in your 20’s and 30’s, you obviously have more
time to rebuild a retirement nest egg, but even if you’re in your 40’s or
50’s, you will want to weigh the cost of paying the high interest of the debts
over time, versus borrowing from your retirement account. The return you get
from paying off high-rate debts is guaranteed – while the stock market isn’t.
Rapid Repayment
There is a mathematically optimal way to pay your debts. Choose a fixed level
monthly payment, and commit to it each month. Pay as much as you can
on the highest rate debt first, while payment the minimums on the
rest.
I almost always suggest consumers with debt start by creating one of these
plans. Many people who do so find they don’t even need to consolidate to get
out of debt in the next few years. They just need a plan and they can do it
on their own.
Overview
The biggest mistakes people make when it comes to consolidation are:
For more details on these strategies, and a complete report
on the best ways to consolidate your debt, visit
www.DebtConsolidationRx.com
.
Copyright 2003 by Gerri Detweiler,
all rights reserved.
Gerri Detweiler
is considered one of the country’s top credit experts. She is co-author
of Stop Debt Collectors Cold, (www.stopdebtcollectorscold.com),
a valuable resource for understanding your rights when in debt. Gerri has
been interviewed in thousands of radio, television and print news stories
including USA Today, The Wall Street Journal,
The New York Times, Dateline NBC and many
others. She has testified before Congress several times and worked on reform
of the national credit reporting laws.
Contact Gerri at:
gerri@ultimatecredit.com
to learn more.
