Watching jugglers makes for fascinating entertainment and, of course, they make it look easy. However, try having a go at juggling yourself, and if you’re anything like me, you’re bound to find that it’s anything but simple. In fact, it’s incredibly tricky to keep everything bouncing around seamlessly. Before you know it, your hands and arms are grasping wildly, and whatever it is you’re juggling soon hits the floor.
Juggling multiple debts is something like juggling balls or bottles. Even if you’re dealing with a comparatively small number of debts, it becomes hard to keep an eye on everything that’s happening at once; almost inevitably, something has to give. You start missing payments, or you lose touch with the rate you’re being charged, with the result that you have no idea whether you’re getting a good deal. And then there’s the difficulty of finding the cash to spread across all the payments. Once you find yourself in this situation, an unexpected bill can become the catalyst that causes the whole thing to fall in a crashing heap.
A possible solution to the confusion and chaos can be debt consolidation— the strategy of paying off multiple debts by folding all of them into a single new loan.
With the right approach, debt consolidation has the potential to make your debts significantly more manageable. And by folding several balances into one loan that charges a lower interest rate, it can also provide an opportunity to reduce your payments and generate savings on interest and other fees and charges.
But it’s very important to stress that debt consolidation is not the quick fix touted by some unscrupulous lending organizations. Problem debt is a complex financial issue, and anything claiming to offer an overnight solution is almost guaranteed to leave borrowers worse off.
The bottom line is that debt consolidation has its place, but, like so many aspects of debt management, it is an option that should be approached with care.
Making debt consolidation work for you
There are essentially three main ways to consolidate debts. The first is to pay out credit card balances using a balance-transfer deal. Alternatively, you can pay off several debts with a single personal loan. Lastly, if you are a home owner with some equity built up in the property, you can fold several debts into your mortgage.
Regardless of which option you choose, there is not much point in consolidating debts if it won’t save you money, and that makes it essential to crunch the numbers to see if the consolidation plan will be an advantage to you.
Start out by gathering all the paperwork for your various debts. The monthly statements will show the current rate you are paying, your regular payments, and any other fees and charges. It’s easy enough to add up the regular payments; but when it comes to working out the long-term interest cost of each debt, it can be helpful to use online calculators such as the one at www.yourequity.com.
Alternatively, if you use a broker, be sure to use a reputable one. He or she should be able to calculate the possible savings that debt consolidation will provide.
Let’s work through an example to see when consolidation can generate worthwhile benefits.
Folding debts into a personal loan
Sue has three credit cards that are all maxed out. One card has a debt of $3,000 that charges 17 percent interest; another has a balance of $2,500 at 19 percent; and the third has $3,000 owing on it at 16 percent. So, when added all up, she owes $8,500.
Sue only makes the minimum payments (2 percent of each balance), which together total $170 per month. At this rate, it will take her more than 25 years to clear the debt, by which time she will have paid almost $16,200 in interest—more than double the amount of the original debt! Note, too, that this figure is based on the very optimistic assumption that Sue makes no additional purchases with the cards.
A simple and straightforward strategy that would let Sue reduce her overall interest and clear her of debts within a definite time frame is using a personal loan to pay off all three cards.
Let’s assume that Sue takes out an $8,500 loan that charges 13 percent and will be repaid over five years. In this case, her monthly payment will be around $194, which isn’t much more than the $170 she currently pays on the three cards. But the interest paid on the loan over the full five years will be about $3,100—a fraction of the money she would spend paying off the cards by using the card issuers’ minimum payments!
For anyone beleaguered by a raft of credit card debt, this can be a very sensible strategy. The set payments provide the discipline needed to pay the debt off in a given time frame, and that’s something you don’t get with a credit card balance-transfer offer. Furthermore, there’s no opportunity to add to the balance, especially if you cancel the cards that got you in trouble in the first place, which is essential to do, lest you start racking up more debt on the plastic.
It’s worth pointing out that in this example, Sue makes big savings on interest charges; though on the flip side, her monthly payments will increase slightly. This is important because people often refinance their debt in the belief that it will lower their regular payments. In many cases it will, but you really need to look at the total interest cost over the life of the debt to see if you are saving money.
The best way to save on debt is to pay it off quickly, and if you’re switching a long-term debt for a shorter-term option, that can mean facing larger, not smaller, payments, even though you will save money overall.
Add up the costs
Whether you choose to consolidate debts by using a balance-transfer deal, a personal loan, or rolling everything into your home loan, it’s essential to allow for additional costs. These can include fees and charges to take out the new loan or discharge the existing debt. Overlooking the impact of fees can cloud the true picture, so it’s very important to ensure that the whole arrangement leaves you better off.
Traps to avoid
Along with the need to be absolutely sure that debt consolidation is providing real savings on interest, there are some potentially serious drawbacks to be aware of and avoid.
Some of the more significant problems arise when using a home loan to consolidate debt. To begin with, rolling credit card balances and personal loans into a mortgage means transforming unsecured debts into a loan secured by your home. If something goes wrong and you’re left struggling to make the payments, you could lose the roof over your head for the sake of what was once an unsecured loan.
Be aware, too, that consolidating debts into a home loan may leave you with fewer avenues for help in the future. Lenders’ hardship programs, for instance, entitle borrowers to request a variation in payments if layoffs, illness, or other unforeseen circumstances make it impossible to keep up with loan payments. However, these programs are only available if the loan meets certain criteria. If the relationship between you and the mortgage holder is a bit tense, the lender has the right to foreclose on the loan and repossess your home.
Address the underlying issues
One of the major problems with debt consolidation is that it fails to address the reasons why borrowers are struggling with debt in the first place. Even with the best consolidation plan in place, there is nothing to prevent a fresh buildup of debt on a newly cleared credit card or further overspending fueled by lower monthly payments. If this happens, it can be the start of a slippery downhill slope to serious financial trouble, and the options for getting out of that debt become far fewer and much tougher to live with.
When overspending or living beyond your means are the key reasons behind a need to consolidate debts, a sensible first option is to establish a household budget. This will put limits in place for everyday spending and offer an opportunity to regain control of your money.
If the do-it-yourself approach doesn’t work, it could be worth a visit to a financial counselor, who can provide valuable mentoring to help you stay on track with a budget.
The important thing is to consider other options for assistance if you’re struggling with debts.
If you’re having difficulty meeting bills for things such as the phone, electricity, and gas, call the provider and ask to speak to their hardship officers. They should be able to help you work out a plan to pay the bill in installments.