Should I consolidate debt ?
Knowing when and how to consolidate debt is tricky. Debt consolidation companies will typically bamboozle you with figures, whipping out spreadsheets to show you how you can consolidate your debts, take advantage of lower interest rates and lower your monthly payments.
Consolidating debt means taking out one loan to cover all your debts, repaying your original creditors and then just writing one monthly check to pay off the consolidation loan. It sounds simple but you need to be sure that this is the right option for you before you proceed.
Calculating how much you can actually save by consolidating your debts is complicated. You need to take into account all your current debts, their interest rates, penalty fees for closing accounts, interest rates and payment schedules on the new debt and any tax implications of transferring your debt.
Although the thought of simplifying your financial commitments into just one monthly check may sound quite attractive you really need to examine the small print on the alternatives. Consolidating your debt will mean terminating other credit agreements; make sure you check for cancellation fees or other financial penalties such as increased interest rates.
The best way to take all these different factors into account is to use an online debt consolidation calculator. This will take the hard work out of labouring over sheets of figures and trying to assess how much you could save if you consolidate debts.
When considering debt consolidation, don't prioritize lower monthly payments over long-term costs and the level of the actual loan balance. Don't be taken in by promises of more manageable repayments, these are usually off-set by a longer repayment plan and this means a greater cost in the long run.
Check the small print of any agreement before you sign it. If the consolidator lets you pay off debts on a lower interest rate make sure it's not just for a limited initial period. Although this may work out cheaper at first, it will almost always be more expensive in the long term. Just remember that financial institutions, whether reputable or not, rarely do anything in the interest of their customers, they are a business and are in the game to make money. Lending is a very profitable exercise and by encouraging you to take on more debts they're guaranteed to earn more interest.
The simplest way to consolidate debt is to move all your credit card balances to a single card to take advantage of lower interest rates (see our page on how to eliminate credit card debt for more on this). Alternatively, you can opt for a loan from your bank or credit union to pay off all your debts and simplify your repayments into one. However, you need to think ahead, the prospect of getting a consolidation loan when you are already up to your neck in debt is pretty slim.
If you own property or are planning to buy property, debt consolidation can be a complicated exercise in mortgaging and debt redistribution. Be very careful when considering this type of consolidation as there are so many factors to consider that it's easy to get confused and mislead on what exactly is the best option open to you. If you own property, home equity loans are often a good option and offer low interest rates. And some of the interest may be tax deductible. However, by securing your debt with your property you are leaving yourself open to a possible repossession should you fail to pay off your debt.
If you do opt to consolidate debt make sure that you close your other creditor accounts immediately. Don't give yourself the option of running up new debts while still paying off the old. Be ruthless about this or you could end up in even greater financial difficulty. And make sure your creditors state the accounts were closed on your request - don't let it look like your creditor closed them.
Remember though, that consolidating debt and getting it under control is only one part of your problem. To stay debt free you need to keep a close eye on your budget and only spend what you can really afford. Debt consolidation can only save you money if you stay focused and on target to settle the debt early. Make sure you only consolidate with a reputable firm (see our page on choosing a debt management company for tips) and read the small print of any agreement before you sign it. Above all, steer clear of debt consolidation schemes that seem too good to be true. They probably are.