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10-13-2003, 05:01 PM #1
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Article: The Best Ways to Consolidate Debt
Next to winning the lottery, a debt consolidation loan is a debtor’s dream. You’ll have one monthly payment – and hopefully be able to finally pay off those debts.
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. 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.
Betting the Farm
With a home equity loan, you borrow against the value of you home, minus any other mortgages. The two major kinds are: 1. A Home Equity Loan – a fixed amount of money for a fixed period of time (sometimes at a fixed rate) and 2. 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, 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.
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.
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 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.
Another option is a debt negotiation company. You stop paying your bills and instead make a regular monthly payment to the company. Your creditors are instructed to contact them and not you about your overdue bills. As your accounts fall further behind, the negotiation company will settle your balances for 50% of your 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.
I am finding this is to be the #1 method clients with a lot of debt are choosing today. It’s affordable, gets them out of debt in a reasonable period of time, and doesn’t require them to file bankruptcy.
It’s not perfect. Your credit rating will be affected 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 or won’t file for bankruptcy, but can’t continue to shoulder the burden of debt they have now, it can be a very good option.
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 next 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.
Do It Yourself
There is a mathematically optimal way to pay your debts. I almost suggest consumers start by creating a comprehensive program showing them how to pay their debts in the fastest way possible. Once they do this, many people 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! You won’t know, however, unless you take the time to create that plan.
The biggest mistakes people make when it comes to consolidation are:
A. Not having a plan for paying the debt off after they’ve consolidated, and
B. Procrastination. Waiting for the “perfect” solution to come along almost always means you’ll end up deeper in debt. Choose your approach, and start getting out of debt today!
For a complete report on the best ways to consolidate your debt, visit www.DebtConsolidationRX.com.
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