When it comes to our debt, we’re constantly looking for some relief. How can I lower my monthly payment, or my interest rate?
One solution a lot of people turn to is debt consolidation. This is when you move a bunch of debts into one singular loan. Typically, this new loan is at a lower interest rate and can drastically lower your monthly payment.
Sounds good, right?!
Here are 3 things to be careful of when considering debt consolidation.
1. Avoid Credit Counseling Services
Credit counseling service companies offer debt management services. This means you sign up with them and they manage your debt for you. You send them a monthly payment and they take care of your debt payments (after slicing a piece off for their fees).
So why don’t I like these? Most credit counseling companies strategically default on your debts so that they can negotiate lower payments. Basically, you send them your monthly payments, they hold onto it (not paying any debts) until the loans default and they can negotiate them for a lower payoff amount. When an agreement is reached, they dip into the fund they built with your payments to pay it off.
The problem with this is it completely trashes your credit. When you don’t pay your debts, your credit tanks (shocker, right?). Not to mention, working with a credit counseling service is looked down on by mortgage lenders. It is seen as the equivalent of a chapter 13 bankruptcy by most mortgage brokers.
2. The Empty Card Syndrome
So now that credit counseling is out, let’s look at your plain old debt consolidation. This is when you go to your bank or credit union to get a loan that will pay off your other debts. So if you have $30,000 spread across 10 credit cards, you take out 1 loan for $30k and essentially move your credit card debt there.
Suddenly you have a $30,000 loan and empty credit cards. The problem here is many people continue using the credit cards after the consolidation. If we don’t make a change in behavior, then there’s a good chance you’ll one day be looking at a $30k consolidated loan AND $30k in new credit card debt.
3. Consolidated Loans Aren’t Always Cheaper
Wait, so I take out a loan with a lower interest rate and a lower monthly payment… how is that not cheaper?
Let’s look a case study. Meet Ted:
Ted decided to take those 3 loans totaling $30,000 and consolidate them into 1 loan:
Hey, the interest rate is less and the monthly payment is half the amount it was before! That looks like a win, right?! Wrong. The problem is the duration. Most consolidated loans can get the lower payments and rates because they extend it over a longer period of time.
In the end, here’s how much Ted will pay:
The consolidated loan was $4,000 more expensive! Not as good as it sounds, is it?
At the end of the day, the best route is focusing on knocking out your debt. If you’d like some help creating an action plan, email me at firstname.lastname@example.org.