Debt Consolidation and Payback Options
In This Chapter
- Determining what you owe
- Strategies for paying off each bill
- Transferring credit card balances
- Refinancing your loans
- Consolidating your debt
You read a little bit about consolidating and paying back debt in Chapter 6. In that chapter, we reviewed the basics of paying back credit card debt. And in Chapter 7, you learned some strategies for paying down your student loans without sacrificing your retirement accounts.
Credit card debt and student loan debt are the two largest categories of debt in the United States, aside from mortgages. And many people get into trouble when they borrow more money than they’re able to pay back or charge too much on their credit cards.
In this chapter, we go a little deeper into what you can do to minimize your payments so you can get out of debt and look ahead to saving for other goals, like college for your kids and your own retirement.
How Much Debt Do You Have?
The first thing you need to do is determine exactly how much debt you have, and that can be a daunting task. If you use auto-pay for monthly payments and don’t pay close attention to your account statements, it’s likely you don’t have a good handle on your loan balance.
Definition
Your loan balance is the total balance that remains on a loan you have. You need to know what your loan balances are to determine how to pay them off.
To begin, make a list of all your loans and credit card balances, noting the interest rates, monthly payment amounts, and due dates for each balance. This can be a very uncomfortable chore, but you must understand your situation before you can start to get it under control.
When you fully understand your debt, make a vow to not incur any more. Use cash or your debit card for all purchases, keeping a close record of what you’re spending so you don’t overdraw an account and incur fees. If you don’t have the cash to pay for something, don’t get it. This might require you to reexamine your lifestyle a bit and get back to living within your budget. If you don’t have a budget, revisit Chapter 3 and make one.
Paying Off Bills, One at a Time
Now it’s time to come up with a plan for getting rid of your credit card debt. Hopefully, it’s not a lot and you don’t have half a dozen cards on which you’ve incurred debt. If you do owe a lot on your cards, you have some options for paying it down.
Some people like to pay off as much as possible on balances that have the highest interest rates while making only the minimum payments on cards that carry lower rates. Starting with the card that has the highest interest rate, pay as much as you possibly can every month to reduce your balance. Once you get one high-interest card paid off, get rid of it and start working on the bill that carries the next highest rate of interest.
Remember that while you’re focused on paying off the credit cards with the highest interest rate, you still have to make the minimum balance payments on your cards with lower rates. Ignoring the cards with smaller balances or lower interest rates means you’ll be charged with fees and your balances will continue to rise.
Paying off your cards with the highest interest rates first is a good strategy, but other people prefer to get the smallest loans out of the way first. This can produce a sense of satisfaction as you pay off a loan and are able to apply the money to another card.
Either way, it’s important to pay as much as you can and not miss any payments.
Transferring Credit Card Balances
You read a little bit about balance transfers in Chapter 5, but it’s important to understand how they work and if a balance transfer might make sense for you.
Basically, a balance transfer allows you to open a new credit card that has a lower interest rate than the cards you have and transfer the balances from your old cards onto the new one. You’re putting the debt from all your cards onto one card.
A credit card company might give you a 0 percent balance transfer card, but most require that you have a good to excellent credit score. If you’ve been scrambling to make minimum payments or missing payments, it’s likely you would not qualify.
Even if you did qualify, there are some things to keep in mind. A balance transfer can save you money over the long haul if you use it correctly to pay back what you owe at a lower interest rate. You’ll need to factor in costs though because many credit card companies charge a fee equal to 3 or 4 percent of the balance you’re transferring. If you’re transferring $10,000, your charge to do so could be $300 or $400.
Another thing to understand is that you’ll need to make at least the minimum payment every month to maintain the 0 percent interest rate. If your payments lag, that great rate will disappear, so be sure you read all the fine print and understand the implications.
And remember that the 0 percent rate is only for a limited time. Would you be able to pay off your balance before higher rates kick in? If not, how will that affect you?
Continually transferring credit card balances can hurt your credit score, so don’t plan on using a 0 percent card transfer until the interest rate rises and then looking for another one.
And remember that most of these cards charge you 0 percent only on the transferred balances. New charges will collect interest at the regular higher rate. Some cards will apply the introductory interest rate to new purchases, but only for a short time.
You need to read and understand all the rules before deciding if a balance transfer is the way to go. If it makes sense for you to be paying off debt you already owe at 0 percent interest, be sure you’re not incurring additional credit card debt, either on the transfer card or a different one.
Alternatives to Balance Transfers
Another way to take charge of your credit card debt is to try to negotiate lower interest rates with the credit card company. If you’ve been a customer for a number of years and have always made payments on time, it’s worth a try.
Ask to have your interest rate cut in half. Most of the time the credit card representative won’t go that low, but it gives you a starting point.
Or look into peer-to-peer (P2P) lending with a company like Lending Club (lendingclub.com). Such online services match loaners with borrowers and often charge interest rates that are much lower than those of credit cards. If you apply for a loan and are approved, you’ll be matched with a loaner. P2P lending is fairly new, so be sure to do some research before applying.
Pocket Change
Nearly 70 percent of people who borrow money from Lending Club use the money to refinance loans or pay off credit cards.
If none of these alternatives seem like a solution, you might want to look at refinancing a loan or consolidating your debt through a credit counseling agency.
You’ve probably heard of people refinancing a mortgage to get a better interest rate. The same can be done for other loans, such as money borrowed to pay for education.
In Chapter 7, we discussed consolidating federal student loans into one payment, so turn back there if you need to. If you have private student loans, or a mix of federal and private, you might want to think about trying to find a better interest rate than what you’re currently paying.
If you have a steady income now and your credit score is good, a bank may be willing to work with you to refinance your loans at a lower interest rate. You’ll need to pay attention to the terms of the loan, as refinancing options vary from bank to bank. Extending the length of your loan may lower your monthly payments, but you could end up paying more over the life of the loan.
Dollars and Sense
Refinancing your college loans through a private lender might enable to you to release the cosigner (a parent perhaps) on your original loans. This can be helpful if the cosigner is looking to pay off a mortgage or start a business.
More and more banks are getting into the student loan refinancing business, so be sure to take some time to see what kind of rates are available and to understand the terms of each contract you consider. Refinancing multiple student loans through a new lender can result in better interest rates and reduced stress by having all your loans at one place.
Considering Debt Consolidation
If you’re at your wit’s end trying to figure out interest rates, minimum payments, and payment dates on several credit cards, you might want to look into consolidating your loans. Just as explained with the refinancing of college debt, you may be able to consolidate and refinance credit card or other debt into one loan with a lower interest rate.
You read about credit counseling and debt settlement in Chapter 6, but there are some things you should understand about debt consolidation before you jump. When you consolidate your debt, you pay back everything you owe—unlike with bankruptcy, in which your obligations are lessened or released.
So although debt consolidation does less damage on your credit report than bankruptcy, it still can raise red flags to potential lenders because they’ll see that you paid your debt through a third party. That third party is the credit counseling agency that collects your money and uses it to pay the credit card companies and other creditors you owe.
Online credit card payoff calculators can help you determine how long it will take you to become debt free. Find one from Bankrate at bankrate.com/calculators/credit-cards/credit-card-payoff-calculator.aspx.
If you’re looking to consolidate your debt, pay close attention to the terms of the new loan. A debt consolidation loan usually carries a longer payback period, so expect that it may take you longer to get out of debt than usual.
Money Pit
Don’t expect that you’ll be able to pay off your debts in a few months—it could take years.
Also, know that debt consolidation is intended to repay unsecured debts, such as credit cards and personal loans. You can’t use debt consolidation for expenses such as unpaid taxes or child support.
Your goal in consolidation should always be to get the lowest interest rate possible. When you find the option that’s right for you, apply for the loan and use the proceeds to pay off your outstanding balances. Most lenders will repay your current debt for you instead of issuing you a check and having you pay. Be sure the loan has a fixed interest rate and a set repayment period, and use any extra cash you save each month to get closer to your savings goals.
Getting your debt under control and repaying credit cards, student loan debt, and any other money you owe is the only way you’ll be able to move ahead financially. Once you’re not worrying about paying high interest rates on your debt, you can start thinking about earning the highest interest rates possible on your savings.
The Least You Need to Know
- The first thing to do when dealing with debt is to calculate exactly how much money you owe.
- Options for repaying credit card debt include paying off the cards with the highest interest rates first, paying off the small balances first, or applying for a credit card balance transfer.
- Peer-to-peer (P2P) loans are a fairly new concept, but they might help you find a lower interest rate.
- Refinancing college loans can get you lower interest rates and lower your payments, but be sure you know exactly what you’re getting into before deciding to refinance.
- Debt consolidation is good for certain financial situations, but it’s definitely not a one-size-fits-all solution.