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Should I Consolidate My Debt?

By: Financial Hotline
Fall 2023 (Vol. 41, No. 3)

The only way that getting new debt to pay off old debt will succeed is if you stop spending on credit. Before you consider another loan, take an honest look at how you got so deep in debt. It is important to understand what triggered credit use so you can make a plan to avoid repeating the same pattern. If you accrued a lot of debt because you had unexpected expenses with no emergency cash, you will need to establish an emergency fund. If you are simply spending more than you earn, a consolidation loan won’t help you unless you commit to changing your habits.

Try looking for extra cash in your monthly budget that you can use to pay down the smallest of all your loans as quickly as possible. Once that debt is paid, take the money you were putting towards that bill to pay down the next smallest debt. Continue until your debts are all eliminated. Also, try reaching out to your individual creditors to see if they will agree to lower your payments. Some creditors might be willing to accept lower minimum monthly payments, waive certain fees, or reduce your interest rate.

If you can’t make the traditional methods work, consolidating may be the answer. Here are some different options:

Credit card balance transfers. A card company may offer zero-percent or low-interest balance transfers for a specific number of months to help you pay more towards your debt by eliminating the interest fees. The promotional interest rate typically lasts less than two years and after that the interest rate on your new credit card will revert to a higher rate similar to any other card. Most balance transfer cards charge a “balance transfer fee.” Upfront. For example, if you transfer $10,000 in debt to a zero percent card that has a 3% transfer fee, $300 will be automatically added to the balance due. If you use the same credit card to make new purchases, you won’t get a grace period for those purchases and you will have to pay interest until you pay the entire balance off in full, including the transferred balance. If you are more than 60 days late on a payment, you will lose your zero percent perk and the card will revert to a higher interest rate.

Debt consolidation loan. Banks, credit unions, and installment loan lenders offer debt consolidation loans. They basically lump all your debts into one loan and offer you a lower rate and therefore a lower monthly payment. Unfortunately, many of the ads you see offer “teaser rates” that only last for a short time After that, your lender can increase your rate and you may find yourself with similar or higher payments. It’s also important to look at the loan terms. You may have a much lower payment but you could be paying for a much longer time. Before signing for a consolidation loan, do the math, compare loan terms and interest rates to see how much interest and fees you’ll pay overall. This can help you pick the loan that saves you the most money.

Home equity loan. With a home equity loan, you’re borrowing against the equity in your home. When used for debt consolidation, you use the loan to pay off existing creditors first, and then you have to pay back the home equity loan. This is a tempting option because these loans usually offer lower interest rates than other types of loans. But, keep in mind, if you don’t pay a home equity loan, you could end up in foreclosure and lose your home. There may also be closing costs associated with any real estate loan so be sure to compare all the extra costs, not just the monthly payment. Home equity can be a safety net for unexpected repairs or other emergencies so be sure to use it cautiously.

Warning: Beware of debt consolidation promotions that seem too good to be true. Many companies that advertise consolidation services may actually be debt settlement companies, which often charge up-front fees in return for promising to settle your debts. They may also convince you to stop paying your debts and instead transfer money into a special account. Using these services can be risky.