Debt is a funny thing. We get into it, and even though we know it’s there, hanging over us, our inclination is to just ignore it or forget about it. We don’t think about paying it off faster or about finding a debt consolidation solution. We just keep pushing it aside and hoping it will go away.
Sadly, debt is a lot like health problems and plumbing leaks: it doesn’t go away. It only gets worse. If you’re ready to face your debt, and get rid of it, then keep reading to learn how debt consolidation could be the answer to your prayers (or the solution to your fears).
What Is Debt?
“Money I owe someone. Simple.” Ok, but hold on: it’s not actually that simple. It’s easy to overlook some of the places where debt can hide in your personal finances.
Debt is money that is owed.
It could be owed because you borrowed it and need to pay it back. It could be owed in payment of services or for goods. Except in really rare cases, debt comes with interest.
Interest is a certain percentage of the debt amount that you agree to pay in exchange for borrowing the money in the first place.
Interest is pretty important!
Without it, the people loaning money wouldn’t have any reason to risk their money by loaning it out!
Interest gives them some way to make money off the deal.
Types of Debt
The most common types of debt these days are credit card debt and loans for buying cars and housing or paying for schooling. Some people have medical debt they own for health services.
Credit Card Debt
This is generally acknowledged to be the worst type of debt. It’s not universally true (some people use their credit cards to pay for things like medical emergencies and other necessities), but most of us use these tempting pieces of plastic to buy stuff we don’t always need. Looking at you, brand new iPhone…
If you had a pang of guilt reading that, be comforted. You’re in excellent company if you carry credit card debt. The average American household carries just shy of $7,000 in credit card debt month on month.
Auto and Home Loans
Car loans and home mortgages are another big area of debt for us. Cars and houses are pretty expensive, so few of us can afford to buy them outright. Unless you’ve bought more car than you need or a ridiculously expensive house, these aren’t such bad debt. After all, we do need places to live, and most people need a car for work and errands.
However, these types of loans tend to come with some pretty steep interest rates. When you first started making mortgage payments, for example, you weren’t paying much at all towards the actual loan.
Say you had a $100,000 mortgage, 25-year loan, with a 4% interest rate. You’d be paying just over $6,500 a year on your mortgage the first year, and $4,000 of that is just interest. It’s going to take a long time to get that loan paid off.
This is what used to be known as “good debt.” You may have heard your grandfather or great-grandmother waxing eloquent about how it’s worth going into debt for a good education.
That’s because 70 years ago, it was. Not everyone got a college education back then, and if you did get it, you were going to be able to pay it off fairly quickly because you could definitely expect higher salaries. Sadly, times have changed.
For one thing, so many people get an undergraduate degree these days that they have become increasingly worthless. Now you have to get a master’s at least to really stand out. For another, college costs keep going up, but the quality of the education doesn’t.
University costs aren’t going to better labs and more qualified professors. They’re outfitting an army of pencil-pushers and admin people that have little to do with education. People are being encouraged to get degrees in subjects that will never get them a job, all in the name of “pursuing your passions.”
This has resulted in a student debt crisis. American students are graduating with tens, and sometimes even hundreds of thousands of dollars in debt. What’s really scary is the number of students who find it difficult to pay off their loans because all that education isn’t guaranteeing them a job.
Once again, “good debt, bad debt” is in play here. If you carry insurance, but they refused to pay, or if you had an unexpected illness or accident that went beyond what your savings and insurance cover, well…better in the red than dead, to massacre an old saying.
Of course, if your medical debt was to pay for the coolest new body mod procedure, that’s different. We’re not here to judge, but we will say that you probably can’t classify this as “good debt.”
Why Is Debt Bad?
The federal government is in so much debt that our great-grandchildren will still be paying off the interest, let alone the principle. Everyone around us is in debt. Is debt really that bad? Do you really need to think about debt consolidation or other solutions?
Debt is bad; even some “good debt.: Here’s why:
It Teaches You to Spend
The first time you bought something you couldn’t actually pay for outright, you might have had a moment of concern. It’s a big step. But then the sky didn’t fall, no masked men came knocking in the middle of the night, and your grandmother did not roll over in her grave.
We get a kind of high from spending. It’s undeniable, and retailers are always working to take advantage of that and urge us to spend. We get tempted to spend because we don’t actually feel the pain of parting with our money in real time. What happens, though, is that debt catches up with us. The good feeling dies really quickly at that point.
You Pay Too Much
Would you have bought that gaming system if it had cost twice as much as it did? Probably (hopefully) not. Yet when you pay high interest rates, like the ones credit cards charge, you can end up paying a lot more than you bargained for.
Let’s say that, once you calculate the interest, you ended up paying $3,500 for something that you thought you were paying $2,000 for. If you’d put aside $100 a month for 20 months, you could have waltzed in and bought the thing outright for the lowest possible price.
You Might Not Be Able to Get a Loan
Picture this: you meet the girl or boy of your dreams next week. You weren’t planning on it. You both drop something at the coffee shop, you knock heads picking it up, you have a laugh, and the rest is history you’ll be telling your grandchildren.
Wow, that was fast! In two years you’re married, and in three you’re starting to think you’d rather not keep shelling out rent money you’ll never see again. Why not pay mortgage payments instead, so that every payment is going towards owning the home you want to grow old in?
Then comes the bad news: you have so much debt already that no one will loan you anything to get a house. Sorry.
You Can Hurt Yourself
Speaking of marriages, do you know one thing that puts an incredible strain on a marriage? Debt. Debt sparks arguments, makes you both feel scared and vulnerable, and can even end a marriage.
It’s not just your marriage that’s at stake. Money woes are stressful, and high-stress levels can lead to serious medical problems (and even more debt). People under constant stress get depressed, develop migraines, and have strokes.
You Tank Your Credit Score
A lot of your credit score is based on how much debt you’re currently carrying. The most obvious reason to keep a good credit score is so you can easily apply for a credit card or loan if you need it, but that’s not all good credit can do for you.
Good credit can lower the cost of other products, like your car insurance. It can make it easier to get credit cards with much lower interest rates. It can even help you score higher-interest savings accounts at your bank.
This is all a lot of bad news, and if you’re starting to wonder whether those are heart palpitations, you’re feeling, then sit down, smell some lavender, and don’t panic. Here’s a kitten:
Debt consolidation is a great way to solve your problem, and we’re about to tell you everything you need to know.
What Is Debt Consolidation?
Debt consolidation is a big term, but it’s fairly easy to understand the concept. Basically, you’re taking your many smaller debts and making them one giant debt. In some cases, you’re asking someone to give you one big loan which you then use to pay off all your smaller debts. In other cases, you’re entering a debt management program and don’t actually take out a loan.
Why Would I Want to do That?
This is a good question and a natural one. There are a couple of good reasons that debt consolidation helps you:
- It lowers your monthly payments to something you can afford
- It offers lower interest rates than the high-interest credit cards
- It makes it easier to keep track of your bills and payment deadlines
Is It for Me?
Whenever you’re thinking about a major financial decision, it’s important to carefully consider the pros and cons. There are some good reasons to consider debt consolidation, and here are some of them:
You’ve Been Late in a Payment
If you fail to make a payment on a loan or credit card bill, you know that the calls start coming in pretty quickly. The people you owe money to are getting…nervous. What they’re worried about is that you’re finally in over your head and might go bankrupt or otherwise stop being able to give them money.
If only they’d been so concerned for your finances back when they were offering you lines of credit, right?
If you miss a SECOND payment; well, you can forget about having any peace of mind. If you’ve had some late or missed payments and are starting to get into the weeds, that’s a good reason to consider debt consolidation. Debt consolidation can take the pressure off and give you time to get your financial house in order again.
You Want to Get Out of Debt Faster
If you have realized that your debt is unsustainable, you certainly want to make a plan for getting out of it. One of the things standing in your way is high minimum payments and interest rates. You can’t chip away at your actual debt because all your money keeps going to those minimum monthly payments. Things get even worse if you start getting hit with penalty fees.
Debt consolidation can help you get erase those high payments and get to work on the principle of your debt, which lets you get out of trouble more quickly.
You Are Having Trouble Keeping Track
If you have multiple bills coming in each month, and each one due at a different time of the month, you risk being overwhelmed or forgetting a payment debt. It’s all too easy to find yourself paying penalty interest rates just because that one credit card company changed the due date by five days and didn’t exactly make a big deal of letting you know.
(Yes, they do that. Yes, it’s legal. No, it’s not ethical. Have a cookie: it’ll be ok.)
Debt consolidation gives you the option to make just one payment on one date. This makes it a lot less likely you’ll forget or miss a payment by accident.
You Feel Taken Advantage Of
Have you ever read one of those “personal schedules of fees” booklets that come with your credit card? Most people don’t. Some of those booklets of terms and conditions are longer than textbooks you used in high school.
Buried in those terms and conditions are phrases like “introductory APR.” This is a common credit card offer. You don’t pay any interest, or really low interest, for the first year. After that, rates skyrocket to…who knows? Whatever the going rate is when your year runs out.
When an individual attempts to negotiate with a credit card company, things don’t often go well. A debt consolidation company has some experience and clout to encourage companies to make your interest payments go down.
Reasons to Pass
Debt consolidation can be a lifesaver, but no plan is for everyone. There are three reasons you might want to pass on debt consolidation.
You’re Afraid of Change
If you’ve gotten into debt through overspending, and you don’t intend to change your habits, then debt consolidation won’t help you. You have to be willing to make a budget and stick to it and commit to paying on time.
You Don’t Have Stable Income
Without a stable income, you can’t really reduce your debt. Debt consolidation will just restructure your debts, and what you may need is actually to declare bankruptcy.
Bankruptcy is scary, but there are plenty of reasons that good, talented people find themselves without a steady income for a time. If you can avoid bankruptcy, it’s always a good idea to do so. But if you can’t, it isn’t the end of the world. You can come back.
You Need to Be Rid of Debt Now
If you’re about to retire and can’t handle your debt, bankruptcy or making a debt settlement might be the right way for you to go. These will be hard on your credit score and future, so they’re not great options if you’re young and can work. But in some cases, they’re the better answer.
Understanding the Process
Debt consolidation is a process, and here are the steps you’ll go through if you choose this path:
Calculate Your Debt
You need to work from a baseline, so that means knowing exactly how much you own. You need to find all your sources of debt and figure out what you owe on the principle and the interest rates you’re paying.
You need to find out how much average interest you’re paying when you put all your debts together. This is an important piece of information that you’ll use in just a few more steps.
Figure Your Income
You know what your paycheck looks like, but where is it all going? If you’ve never done this before, it’s time. Calculate all the expenses you HAVE to pay. These would be utilities, food, and housing costs, for example.
Subtract those from your monthly income. Whatever is left is the amount you have to put towards your debt.
Does that amount look too small? Then start thinking of ways you can cut back. Do you really need cable, for example? What if you started making coffees at home rather than swinging by Starbucks? Are you actually using the gym membership?
Contact a Debt Management Program
A lot of us don’t really know how to cut back. Let’s face it: if we were good at keeping track of our money, we probably wouldn’t have so much debt in the first place.
We also tend to get discouraged. When you started college, do you remember that orientation class where they told you not to panic when you get the syllabus for each of the classes? Why did they do that? Because they know it’s human nature to look at all the deadlines and go into a frenzy thinking that it’s all due RIGHT NOW.
Choose a Type of Plan
Your next step is deciding whether you want to do debt consolidation with or without a loan. Here’s what that means:
With a Loan
In this step, you get a bank or credit union to loan you enough to cover all of your debts. You pay off all the student loans, auto loans, and credit card debt and you negotiate a monthly payment and interest rate you can manage.
The key here is whether or not you’ll be able to get an interest rate on this loan that is lower than the average interest rate you’re already paying. If it’s not, then doing all this actually doesn’t help you.
If you’ve got a home, you might be able to get a lower interest rate home equity loan. Basically, you’re putting your home up as collateral to pay the debt, which makes lenders willing to give you better interest rates. Just be careful: if you default, you could lose your house.
Without a Loan
There are credit counseling programs and debt consolidation organizations that will help you deal with your debt in a different way. Instead of taking out a loan, they contact your creditors and negotiate with them to get your interest rates lower.
In this case, your new friends are calling your creditors and telling them that you’re reaching the end of your financial rope. If they want to get money from you, their best bet is to work with you: otherwise, you might have to default, and then they get nothing.
Creditors are remarkably amenable to this kind of reasoning, especially when it comes from a consolidation company that they know has taken a look at your finances and knows the situation.
Once you consolidate your debt, you have to keep paying. If you start missing payments again, whatever deals you made might be revoked.
Get Some Help
If you’re in debt because of something you can’t help, like an unexpected medical emergency, then you might not need this step. But if you’re in debt because you’ve had trouble controlling your spending (and again, you’re very far from alone in that if you are), then a debt management program will probably recommend that you get some counseling to help you learn how to spend, save, and budget.
What Are the Alternatives?
If you are on the fence about debt consolidation, but you know you have to do something about your debt, then it’s time to look at a couple of the alternatives. There are three: bankruptcy, settlement, and counseling.
If you’ve reached the point where you’re totally unable to pay back your creditors, then you can file for either Chapter 7 or Chapter 11 bankruptcy In Chapter 7, you offload some or all of your debt completely. In Chapter 11, you repay a part of it.
Once you declare bankruptcy, some of your money and your belongings must be turned over to your creditors. A certain amount is exempt, but you’ll lose a lot. Once it’s done, though, your creditors don’t have a debt in your name and can’t come knocking.
- You’ll get to start over fresh, financially speaking
- You keep retirement savings, work-related items, your car, and possibly even your home
- It only takes a few months, and then you’re done
- You can’t get a credit card, which limits your ability to do a lot of things (like rent a car or stay in a hotel)
- The bankruptcy affects your credit report for a decade
- Most of your things get sold off to pay lenders
Bankruptcy, as you can see, is an option, but it’s not a very attractive one. For some people, it’s the only answer. But for most of us, it’s a good idea to avoid it if we can.
In a debt settlement, you go in with your creditors and do what we described a debt settlement company as doing: you negotiate a reduced balance. If you have a lot of creditors, this can get pretty difficult.
- If you do it right, you may able to slash your debt by as much as half
- If you’re facing lawsuits, this could be a fast way out
- Not every creditor will be willing to work with you
- You’ll have to pay taxes on the forgiven debt
- Your credit score will suffer for seven years
Again, this might be the right answer for some people, but for a lot of us, this is going to hurt. You might not be able to afford to pay the taxes on your settled debt, and you might suffer with a low credit score for a long time.
If you’re not too far in debt, then counseling might be the way to go. If you’ve never had anyone help you understand how to manage your money, this could be very helpful.
- Free! It’s easy to find non-profit organizations that will help you
- No mark on your credit report
- Doesn’t actually get rid of any debt
- May be hard to find a certified counselor
Credit counseling can be one of the most helpful things you ever do: but only if your situation is such that you can get out of debt without reducing minimum payments or getting rid of some of your balance.
1. Does the IRS Tax a Debt Consolidation Loan?
Nope! You’re in the clear. However, you won’t be able to deduct the interest payments on the loan unless you’ve actually put up some collateral.
2. How Much Does it Cost?
In most cases, you’ll pay a one-time fee or a small monthly fee to the consolidation company. These fees are usually quite low.
3. What Will Future Lenders Think When They See Debt Consolidation On My Record?
As long as you keep paying off your debt, things won’t be too bad. A lender would MUCH rather see you making an effort to deal with your debt than see that you went bankrupt.
4. Is This a Guaranteed Fix to My Debt Problem?
No. The only one who can guarantee a fix (at least as far as anything can be guaranteed in this life) is you. Only you can get you out of debt, and only you can keep you out of debt.
It never hurts to do a little Google-sleuthing and make sure the company has a good reputation online and with places like the Better Business Bureau.
Get the Feeling
Debt might not seem all that bad when you’re first getting in it, but over time it’s putting more stress on you, your family, and your relationships than you might think.
One of the best feelings in the whole world is getting out of debt. It’s like losing 50 pounds or a kid finding out that school was canceled for the month. Take charge of your debt and get your life back. Hardly anything will ever feel better.