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Why Is Debt Consolidation a Good Idea?

Updated on November 13, 2018
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I've loved personal finance for a long time and have helped my friends and am seriously considering a career as a financial advisor.

Debt Consolidation
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What is Debt Consolidation?

Are you in trouble with credit cards? Do you owe thousands of dollars of your college loan? Did you ask for a new loan for a car? The minimum monthly payments are not doing any trick to help you pay off your total debt, right? Something has to change and you are already considering the reunification of debts as an alternative to your financial health. The first step is given, let's continue ...

Enter the world of debt is very easy: you go shopping, you choose what you like, you pass your credit card and you forget everything that follows. Very simple, no? You do not have to worry about paying your card statement for a few weeks until the end of the month.

Getting out of debt can be difficult. You will need to check all your available options to see which one makes the most sense for your financial situation, budget and income.

You may have heard of several debt-gathering agencies that announce quick relief of their obligations.

Since there are several different methods to relieve debt, it is important that you look for the type of help that is right for your situation.

It is basically taking out a large loan from a bank or credit union and using that money to pay several smaller debts. This process is very common especially in the United States.

In effect, multiple debts are combined into a single larger debt, usually with more favorable terms of payment: a lower interest rate, lower monthly payments, or both.

Consumers can use debt consolidation as a tool to deal with student loan debts, credit card debts and other types of debts.

This can be effective, unless you have a less than perfect payment history and a low credit score, which means you may not be approved for a debt consolidation loan.

What is the most important thing to keep in mind in this process?

Here are the most important things you need to know before consolidating your debt:

Debt consolidation is a refinanced loan with extended payment terms.

The extended payment terms mean that you will be in debt for longer.

A lower interest rate is not always a guarantee of a better loan.

Consolidation does not mean the elimination or liquidation of debts.

What alternatives do I have to consolidate my debts?

Pay the debts yourself

Obtain a debt consolidation loan

Transfer your balances

Solve and settle your debts

Hire help from an agency specialized in these negotiations (it is NOT free)

1. Pay the Debts Yourself

Do not believe anyone who tells you that you can not pay your debts on your own. It is entirely possible to gather the necessary financial resources to reduce and eventually eliminate your balances forever. To do this, you will have to pay your debts one at a time.

You could start by paying the credit card with the highest interest rate while still making the minimum payments on your other credit cards. First, he will pay the cards with the most expensive interest, and thus minimize the payment of long-term interest. This is called the debt stacking method and is suggested by many experts because in the long term it will save you more money.

However, it can take a long time to pay a high interest credit card, especially if you have a large balance.

To pay the total debt, you will have to persevere and simply continue with the plan month after month.

The second way to pay off credit card debt is called the Snowball method. Yes, that's what it's called :) Dave Ramsey developed it (you can find it as "The Debt Snowball method").

If you were to choose this method, you would put your credit card debts in order from the one with the lowest balance to the one with the highest balance and then put all your efforts against paying the one with the lowest balance .

The idea behind the Snowball method is that you would be able to pay one of your paid credit cards fairly quickly and then have extra money available to start paying off the credit card with the second lowest balance and so on.

We have seen examples where people could pay $ 20,000 in debts in just 27 months.

Dave calls it the snowball method because as you pay each debt, you gain courage to pay off the next credit card debt and so on for all those who follow.

Unfortunately, it is difficult to gather the discipline necessary to stay on track during a self-managed debt payment plan. Such a plan may also require you to make uncomfortable cuts in your family budget or even get a second job. It is possible that you and your family are not willing to make such sacrifices.

A second way to have debt under control and fully paid is with a debt consolidation loan.

If you own your home and have some equity in it, you may be able to obtain either a home equity loan or a home equity line of credit (HELOC - Home Equity). Line Of Credit).

Then he would use the loan funds to pay off all his other debts. You would only have to make one payment per month, which should be considerably less than the sum of the payments you are making now.

The reason for this is that any of these loans would have a much lower interest rate than the average interest rates that you are paying now.

If you are paying an average of 15% or even more of your credit card debts and were able to consolidate them into a variable rate loan on the accumulated value of the home, your interest rate could fall between 4% - 5% or less , depending on your credit scrore, status and bank.

And the interest in a HELOC of interest only could be even lower.

If you do not own your home or do not have much capital in it, the alternative would be to obtain a personal loan without collateral. These are called unsecured loans because they do not require you to use any assets as collateral to insure them.

These loans typically have higher interest rates than secured loans and can be more difficult to obtain if you are already having a big problem with your debts.

Transfer Your Balances

If you have several credit cards and especially if they are high interest cards, another option would be to make a balance transfer to either a card with a lower interest rate or, better yet, a balance transfer card with 0% interest.

If you were able to transfer credit card debts that average 15% to a new 12% you would have a lower monthly payment and this could make it easier for you to reduce your credit card debts.

An even better deal would be to transfer those debts to a balance transfer card with 0% annual interest, which would give you an interest-free timeout between 6 and 18 months during which you would not have to pay any interest at all ( 0% APR).

This means that all your payments would go against the reduction of your balance and you could be debt free before your promotion period ends.

If this sounds like a good option, be sure to read the fine print before signing up for the new card. You could have a high transfer fee that would eliminate some of the savings you would make by transferring your debts.

You also want to check what your interest rate will be after your promotional period ends, as it could be as high as 25%. That would not matter much if you could pay off your entire balance, but if not, you could end up back in the credit card jail.

Balance transfers and debt consolidation loans have something bad in common. Nor will he do anything to reduce his debts.

If you owed $ 20,000 and transferred them to a debt consolidation loan or to a new credit card with a lower interest rate, you would still have to pay the $ 20,000. And while a debt consolidation loan could have a much more favorable interest rate, it will cost you more in the long term because it will take a much longer term.

The loans with mortgage guarantee can be up to 30 years and a line of credit with mortgage guarantee is usually 7 or 10 years. In comparison, if you chose to pay off those credit card debts yourself, you could have them fully paid in 3 years or less using the SnowBall method.

Solve Your Debts

Another way to achieve relief from those terrible credit card debts is through the settlement of debts. It can be better than a debt consolidation loan or a balance transfer because when done successfully you can reduce the amounts you owe.

The way this works is simple, at least in theory.

All that is required is that you communicate with each of your creditors and offer to make a single payment to settle the debt but for less than its nominal value.

For example, if you owed $ 5000 on a credit card, you could contact the issuer and offer to make a one-time payment of $ 2,500 to settle the debt. If you can prove that you are experiencing serious financial problems, your credit card company could reach an agreement for the $ 2,500 offered.

You will need to have the documentation available to prove that you really have a serious financial hardship including a list of all your debts, the amount you owe on each, the last time you were able to make a payment for them and any minimum payments made.

You will also need to have a list of your assets and your earnings.

The point here is that you should be able to prove beyond the shadow of doubt, that you simply can not pay your debts and if the card issuer refuses to negotiate with you, then your only option will be to declare bankruptcy .

In fact, in some cases you can carry the threat of filing bankruptcy (or bankruptcy in English) or at least infer that this is what you are about to do, since it is the most powerful weapon to get a company, such as a credit card, negotiate with you and accept your offer.

The settlement of debts by this method requires 2 things:

First of all you have to be a very good negotiator, since you will face very clever people with a lot of experience in negotiating debts.

Secondly and here is the really difficult part, you need to have the cash (cash !!!) on hand to pay for any deal you can negotiate. The overwhelming majority of credit card companies will refuse to negotiate with you unless you can immediately pay for the agreement in cash - either through a bank transfer or certified cashier's check.

What is a debt negotiation company and what do they do?

The simplest explanation is that a debt negotiation company is a for-profit organization that liquidates people's debts for them.

They do so by offering payment agreements to creditors for less than the total balance. When a creditor agrees and accepts the payment or payments, it will treat the debt as paid in full.

Choose the help of a dedicated company to negotiate your debt.

Instead of trying to solve your debts yourself, which can be very difficult and time consuming a better option would be to hire a company that conducts the negotiation of your debts, for example https://www.thedebtsreliefreviews.com. This trustworthy website provides information on how to solve your debt problems through debt consolidation.

They have already helped more than 100,000 families in the United States to get rid of their debts since the company was founded in 2008. They have achieved this by helping eliminate more than $ 100 million in unsecured debt.

They are almost always able to negotiate better deals than individuals on their own due to their experience and expertise.

These services are NOT FREE, but they can help you at the end of accounts.

They do not charge fees in advance and do not charge anything until they have paid off all their debts to their satisfaction.

Is Debt Consolidation Good?

It depends on your individual ou decide to follow this path, here are some things you should keep in mind.

Debt consolidation vs. HELOC

For homeowners, debt consolidation is usually reduced to a mortgage refinance loan or to a credit line on the accumulated value of the home (HELOC). A mortgage refinance loan is obtained by refinancing your existing mortgage. This allows you to obtain additional funds to pay the outstanding debts to consolidate all your debts in a single payment.

A HELOC allows you to obtain a lower interest rate and a higher credit using the capital accumulated in the home as collateral. Under this agreement, the interest rate only applies to the funds you actually use. Just like debt consolidation loans, you enjoy a simple monthly payment.

A third option that owners can consider is the second mortgage. This method allows you to access funds to settle debts using the capital of your property.

Prepare a monthly budget

While debt consolidation is here to help you, it should only be seen as an interim measure on your path to financial health.

This means developing the right money management skills and keeping credit card debt under control. After all, getting a debt consolidation loan and then maximizing your credit cards repeatedly does very little to improve your financial health.

Tip: With an application for your cell phone you can take the expenses daily and organize your financial life and that of your family.

One of the most effective ways to keep track of income and expenses is to develop and refine a monthly budget. This can help you avoid becoming indebted by paying your bills at the last second.

Determine how long it will take to pay off your debt.

In addition to your monthly budget, you should also have in mind a final goal as to when you expect to pay off your credit, installment loans and car payments.

Therefore, your monthly payments should take into account how much you can pay and the maximum amount you can contribute. The sooner you pay your debt, the better. That is why it is important to calculate the life cycle of your debt and try to shorten the total payment as quickly as possible.

When Is Debt Consolidation a Good Idea?

Success with a consolidation strategy requires the following:

Your total debt does not exceed 50% of your income.

Your credit is good enough to qualify for a 0% credit card or a low interest debt consolidation loan.

Your cash flow consistently covers your debt payments.

You have a plan to avoid accumulating debts again.

Here is a scenario in which consolidation makes sense: Let's say you have four credit cards with interest rates ranging from 18.99% to 24.99%. You always make your payments on time, so your credit is good.

You could qualify for an unsecured debt consolidation loan at 7%, a significantly lower interest rate.

For many people, the consolidation reveals a light at the end of the tunnel. If you take a loan with a term of 3 years, you know that your total debts will be paid in 3 years, assuming you make your payments on time and manage your expenses.

On the contrary, making minimum payments to credit cards could mean months or years before they are paid, all while accumulating more interest on the initial capital.

Signs that you must consolidate your debts.

Here are some signs to keep in mind that consolidating loans could be a good idea for you:

You are spending more money than you are earning.

The balances of your credit cards are growing, not decreasing.

The interest payments on your credit card debt exceed the amount purchased each month.

He is paying only the minimum payments on his debt and even that is difficult.

You have been refused a installment loan from a credit card or a store because you have a high ratio of debt to income.

You have debts in more than 5 credit cards.

It is approaching or is in the limits of your credit card.

When invoices arrive by mail (or em @ il), you are afraid to open them.

It has a balance in credit cards with interest rates higher than 18.99%.

Your credit score is going down.

When Is Debt Consolidation a Bad Idea?

Consolidation is not a miracle solution for debt problems. It does not deal with excessive spending habits that create debts in the first place. Neither is the solution if you are overwhelmed by debt and have no hope of paying even with reduced payments.

If your debt load is small (you can pay it within six months to a year at your current rate) and you would save only a negligible amount consolidating, do not bother.

Instead, try a method of paying debts on your own, such as the Debt SnowBall method.

What debts can be consolidated? All?

The following debts are eligible for the consolidation program:

Credit card debts

Medical debt

Expired public services

Unsecured loans

Collection accounts

Payday loans

The average interest rates on credit cards this year were 16.06%. The interest rate on debt consolidation loans depends on your credit score, but if your score was above 640, you could get a loan for just 7%.

Guaranteed debts such as homes, properties and cars can be refinanced, but they are not considered good candidates for debt consolidation because you are putting a valuable asset at risk.

The house could be repossessed or the cars seized if you do not make the payments.

How bad is debt consolidation for credit?

Sometimes, in life, you may feel that it would be best to divide a problem into small, manageable pieces and then approach them one by one. Other times it would make sense to combine them and solve them once and for all.

When it comes to debts and fees, the latter is actually a good idea. If you are plagued by numerous debts, credit card fees and your credit score is also suffering, debt consolidation is the first step to solve your problems and be debt free.

Debt consolidation and refinancing is NOT bad for your credit score.

In fact, the credit agencies favorably consider the intelligent refinancing performed by the clients. They see this as a sign that you are trying to pay off your debts and be more responsible about the use of credit.

What are the risks of a debt consolidation loan?

There are several risks associated with debt consolidation. These can have significant long-term effects that can be problematic for a consumer seeking to solve their debt problem.

Risk of accumulating debt again

Consumers who have not worked hard and without discipline to pay off their debt, then run the risk of repeating the same mistakes and ending up with an even bigger debt problem.

Actually, debt consolidation loans only change the debt to another form.

Although it may be at a lower interest rate and have a lower payment, it will still take a long time to resolve.

Many times, after debt relief, consumers will find themselves accumulating credit card debts again very quickly. If you do not change your spending habits, the amount of monthly cash flow created with debt consolidation could decrease rapidly. Those who have never learned how to budget and manage their money will find that very little will change for them with a debt consolidation loan.

They are likely to continue to exceed their monthly income and depend on credit cards to make up the difference.

Risk of paying more long-term interest

Debt consolidation loans that use the goodwill (or equity in English) of the consumer's house, while producing a lower interest rate and payment, will have a long-term loan term.

Most mortgages have a loan term of 30 years; therefore, even with a lower interest rate, the consumer is likely to pay more interest during the life of the loan.

If you are considering using the equity of your home, you must do the due diligence to determine if it is economically feasible and prudent to include the credit card debt in your home mortgage.

A few calculations to compare the interest you will pay using different consolidation methods will give you a clear idea of ​​the right scenario for you.

Queries and frequent questions.

How does a debt consolidation loan work?

Simply is a personal loan allows you to pay your creditors yourself, or you can use a lender who sends money directly to your creditors.

Is it a good idea to consolidate credit card debts?

Consolidate your debt if you can obtain a loan in better conditions and / or help you make payments on time. Just make sure that this consolidation is part of a larger plan to get out of all your debt.

How long will it take me to pay $ 10,000 in credit card debt with an interest rate of 17%?

If you make a payment of $ 225 per month it will take 71 months or almost six years to pay off your credit card debt.

And only the interest will cost you $ 5,887 for a total outlay of $ 15,887.

But look what happens if you double that monthly payment to $ 450. You would get rid of that debt in just 27 months.

And you would pay only $ 2,094 in interest ... a saving of $ 3,792.

I have a bad credit score. Can I get a debt consolidation loan?

Your credit score is a reflection of how you handle your credit and your debts. A bad credit score shows that you have not handled your credit accounts responsibly, so it is unlikely that a new creditor will offer you a debt consolidation loan with a low interest rate.

Even if you do not qualify for a debt consolidation loan, there is a way to reduce your debt and save some money in the process.

It is called debt negotiation also known as debt settlement. You can negotiate with the creditor or debt collector to settle your debt for less than you owe. Of course, your lender will have to accept the agreement and agree to cancel the rest of your debt. Most of them will agree to reach an agreement, since they will not get anything if you decide to declare bankruptcy.

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    • SgtCecil profile image

      Cecil Kenmill 

      18 months ago from Osaka, Japan

      Well-written and thorough. Good stuff here. Great work!

    • profile image

      Yvonne Nealy 

      19 months ago

      Very useful article...

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