Pros and Cons of Consolidating Your Debt
Being in debt can suck you dry of any and all of the money you make. Interest payments, minimum payments and extra fees can all add up. By paying only the minimum payment, you’ll never get ahead; you’ll just continue in the same vicious circle. For example, if your minimum payment is $100, on average, about $87 of that is just going straight towards your interest. Unless you out down serious payments each month to actually attack your debt and not just the interest, it’s going to be very hard for you to get out of debt. This is why it may be useful to consider consolidating your debt in order to help you out a bit financially.
The Pros and Cons of Consolidating Your Debt
What is Debt Consolidation?
Debt consolidation is essentially borrowing some money at a low interest rate to pay off your high interest debts. This way, you can save a lot over the long run in the interest rates and you only have to worry about making one payment per month instead of multiple payments spread across multiple debts. This can be an effective way to pay down your debt faster since more money will be going straight towards your debt and not just covering the interest. This is especially helpful when trying to get rid of your debt with high interest rates such as credit cards.
When it comes to dealing with credit card debt, one of the best things you can do is try to lower your rate in the first place. If you’ve had your credit card for more than 6 months and you’ve always made your payments on time, it’s worth it to give the credit card company a call and get them to lower your interest rate. Competition is fierce in this marketplace and many lending institutions will agree to lower your rate or switch you to a lower card in order to keep your business. What if they say they can’t do anything? Ask to speak to their supervisor. Also, don’t be afraid to call back a few times to speak to different representatives; you might get a deal from one but not the other, so it’s worth it to give it a shot.
Once you’ve lowered your rate it will be much easier on your debt. You can use this to your advantage by paying off your higher interest debts with your new lower interest credit card. If you’re not comfortable using a credit card, you can always try taking out a loan to consolidate your debt.
One of the aspects to watch out for, however, is that no matter where you got your loan from, use that loan to pay off your existing debts; many people end up taking the loan, spending it on miscellaneous items and then being even further in debt then they were before. Before taking out this loan, make sure you have the self restraint to use it properly and effectively; after all, this is supposed to be a tool for helping you eliminate your debt, not building up more.
If you have decided that this is the right choice for you, the next thing you need to decide is where you will get this loan from. There are many ways to get a loan to help consolidate your debt including from your home, from your savings/investments or getting an actual personal loan either from your friends and family or from the bank or other lending institution.
Consolidating Your Debt From Your Home Equity Line of Credit
If you currently own your own home, you can easily get some extra cash by refinancing your home and using that money to pay down some existing debts. You can also take out a home equity line of credit or a fixed rate home equity loan. If you choose to take out this loan, it is important to remember not to take too long to pay it off. This is especially helpful if you shop around for a great deal, so you can save even more on closing costs. Any extra money you end up saving due to this home equity loan can be put towards your debt even further to help you pay it off faster
Consolidating Your Debt From Your Savings/Investments
An excellent way to pay off some existing credit is to dip into your savings or your investments. You can use your 401(k), RRSP, IRA, any stocks or bonds you might have, or even just straight up cash form a savings account in order to pay off some of your debt. You may be hesitant about this idea if you are the type of person who likes to have options and backups to fall back on, but consider the amount of money you are spending each month purely on interest.
If the interest (or profit) on your savings or investments ends up being less than the payment you have to make on your debt strictly because of the interest payment, you might want to consider using your nest egg to help you get out of the negatives and save money on interest rates. You don’t have to use up everything; you can always just take out half (or whatever amount you feel comfortable with). This way you’ll still have savings, but your debt will be substantially lower as well. These are great ideas if you have either bad credit or no credit, since these options are easy to get.
The downside of pulling money out from your investment plans is that there are generally rules on how to do this. For example, if you dip into your IRA, you can use the money for 60 days without any interest. However, it is imperative that you “rollover” the money to another IRA account within 60 days or else you will have to pay an extra penalty as well as taxes. As a result, many of these methods tend to be for getting some quick short-term cash, not for a long-term debt strategy. Another con is that you don’t want to end up depleting your emergency fund or your retirement fund in case something should happen to your main source of income. It is advisable not to take out more than 25% of your investments for the purposes of your debt.
Consolidating Your Debt From Your Personal Loan
The last way of consolidating your debt is to get a personal loan either from your friends and/or family or from a banking institution. If you are planning on borrowing money from your friends, make sure you have a strong relationship; many friendships have been broken over money. When borrowing money from your friends or family, you can generally get a much better lending rate than through a bank, however, if there are any issues with the payment or being able to pay it back, it could in turn hurt the bond between yourself and those closest to you. Some people just don’t want to risk that.
If you are going ahead and taking a loan out from your loved ones, it is recommended that they take the money out from an entirely separate account you give them a bunch of post-dated cheques right on the spot so there is no future confusion or arguments about how much you owe, whether or not you already paid them this month etc. Try and keep it as organized and professional as possible.
If you decide to take out a personal loan from a banking institution, it can work to your advantage as well; if you add in a new loan to your diverse mixture of loans and stay on your regular payments, it will have a positive effect on your credit score. However, if you already have really bad credit, it may be difficult for you to get this type of loan in the first place. If you are offered a loan, it may be a rather high interest rate putting back at square one.
The good side of this method of lending is that if you set up the personal loan for three to five years, you will be “forced” to stay on track with your debt consolidation schedule. You can also get the payments taken out of your account automatically every month so you don’t have to even think about it.
Conclusion
In conclusion, consolidating debt is a great idea and is worth looking into if you have massive outstanding debts, but it is not for everyone. Make sure you look carefully at the type of loan you want and weigh the pros and cons before deciding. Once you get the loan, use it to your advantage to pay off your debts even faster and the most important thing of all is not to get into that much debt again.
The Image used in this post is taken from Image: vichie81 / FreeDigitalPhotos.net
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