|A consumer educator and advocate, Gerri Detweiler has been helping Americans
solve their credit problems for more than a decade. She is the author of
Ultimate Credit Handbook (Plume, 1993, revised 2003), which was featured in
Money magazine as one of the five best new personal finance books of the
year when released. You can reach Gerri by
visiting her web site
or listening to her
Next to winning the lottery, a debt
consolidation loan is a debtor’s dream. With one monthly payment and a fixed
monthly payment schedule, you can actually see an end to those monthly
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
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
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.
Home Equity Loans
With a home equity loan, you borrow against the value of you home, minus any
The two major kinds are:
- A Home Equity Loan – a fixed amount of
money for a fixed period of time (sometimes at a fixed rate)
- 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, low
payments, 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.
Cash Out Refinance
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.
One option to consider: an interest-only loan. By lowering your monthly
payment, you can free up money to use toward paying down other high-rate
debt or building a retirement fund.
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
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.
Debt settlement is another option that’s become increasingly popular with
consumers who have a lot of debt and can’t, or won’t, file bankruptcy. You
stop paying your bills and instead make a regular monthly payment to the
settlement company. Your creditors contact them, and not you, about your
overdue bills. As your accounts fall further behind, the negotiation company
will settle your balances – usually for 50% of the 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.
It’s not perfect. Your credit rating will be hurt 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 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 nest 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.
There is a mathematically optimal way to pay your debts. Choose a fixed
level monthly payment, and commit to it each month. Pay as much as
you can on the highest rate debt first, while paying the minimums
on the rest.
I almost always suggest consumers with debt start by creating one of these
plans. Many people who do so 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.
The biggest mistakes people make when it comes to consolidation are:
For more details on these strategies, and a
complete report on the best ways to consolidate your debt, visit
The well thought out
information--DebSmart is tremendous!"