The Debt Consolidation Myth
If you are in debt, and it’s stressing you out and holding you back, and generally, putting you in a bad mood, decide right here and now that getting out of debt is your top priority.
Perfect timing. Jesse just wrote a practical, to-the-point guide to tell you exactly how to get out of debt and stay out of debt.
It’s everything you need to know to get out of debt—as soon as possible—in one quick read.
If you’ve got lots of debt, you’ve heard the offers … Consolidate your loans and save! Lower your monthly payment! It’s the easiest way to get out of debt! If you have a list of credit card and student loans long enough that it becomes difficult to count, let alone add up what you owe, you’ve considered—or at the very least—been tempted by the offers to consolidate your loans.
So … Should you?
The short answer is probably not.
What You Might Not Realize…
First, consolidating your loans isn’t the same thing as eliminating your debt. It’s a new loan. Trading three donuts for an entire cheese danish ring doesn’t make your breakfast less dangerous.
Second, that lower payment consolidation promises to deliver often comes with a price—a longer repayment period. This is how many student loan consolidations work. Sure, taking twenty years to pay your loans instead of ten will reduce your monthly payment. It will also double the total cost.
Third, while your monthly payment will be lower, you’ll be making debt payments for longer. We want you making make decisions about all your dollars, not having them spoken for by past debt. More years on your repayment period means more years slave to your debt, more time sacrificing flexibility in your financial life.
That’s all pretty definitive, right? But I did say the answer to loan consolidation was probably not—because when one answer is right ninety-eight percent of the time, that still leaves two percent.
If You Are The Two Percent…
Consider the possibility of thinking about it. Maybe. And only under these narrow circumstances:
One, when you can actually get a loan modification out of the deal. Unlike a consolidation, a loan modification actually lowers the principal amount you have to repay, which can mean lower total costs in the end.
Or, two, if the change in your interest rate you’re is significant. Let’s say you’ve got $5,000 in credit card debt on three cards, at 23% (how do they get away with that?). That will cost you $1285 in interest to pay back over two years. If someone is willing to consolidate those loans with a four-year payback (longer, usually bad, be careful!), but charge you only 6%, that will cut your interest cost to $636.
(And now, be careful again. They may want to charge you a $700 fee for the consolidation, and suddenly your interest savings is *poof*!)
Can you pay less principal? Does the reduced interest rate, once you’ve accounted for time and fees, actually mean paying back less? Then you can consider it. Carefully. (Did I say that already?)
A Better Way Out of Debt
A lower payment! It sounds so good! You’re right. A lower monthly payment would improve your cash flow, and that would be a good thing. But there’s a better way.
Prioritize, Prioritize, Prioritize
Use that budget to make sure you’ve got money for your obligations and the unexpected. Throwing piles of money at your debt is no good if next month’s dentist bill is going mean maxing out your card again.
Then, choose the debt you’re closest to paying off – the idea is to get rid of one of your debt payments as quickly as you can. Any money that isn’t accounted for in step #2, you’re going to use to pay this off as soon as possible. Get it gone and improve your cash flow – because that’s where your stress comes from.
Make just the minimum payment on your other debts. They’ll get their turns.
Re-Evaluate And Repeat
It may make sense to turn around roll all your newfound cash flow into the next debt in line. And it may make sense to beef up your budget for medical emergencies or clothes for the kids – something you could pay cash for instead of reaching for a card like you always did before.
Quick Fixes Aren’t Usually Quick & Rarely Fix Much Of Anything
If you’re deep in debt, promises about getting out, tend to sound good. Really. Good. But too many “solutions” out there are just accounting tricks that will cost you more in the long run. Instead, get organized, get prioritized, and tackle your debts one at a time. You’ll be truly free of them before you know it.