by: Brian May
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Debt Consolidation....How could you not think about it? Several times a week you are presented with the "best option" for debt consolidation through either the mail, a telemarketer(we all love them), e-mail, or advertising online, just to name a few. Do you find it strange that so many people are concerned with your well-being and financial stability that they want to help you? Don't be. There are obvious reasons that we all know, that companies want your debt. Huge Profits! They have the statistics and know the trends that most people will only make minimum monthly payments which over the term of the loan pays them back at least 4 times the amount and from the temporary increase in available cash, most people repeat the same spending habits that caused the need for consolidation in the first place. More opportunity for the companies.
But debt consolidation can be a great thing if used correctly. There are varying opinions about this from the many financial "experts" of the world, but my personal belief is that we all make decisions necessary to solve our current problems and give us added peace of mind. Now the decisions do not always give the results we hope for and may not be the best decisions for long term planning, but I do believe people make what they think are the best decisions at the time. It is pretty easy to look back and question some of the financial decisions we made, we all do, but the problem with doing this is only analyzing the decision and not the many other factors that were in play when the decision was made. ex family, job, relationship, sanity, etc. When deciding if debt consolidation is the best thing for you, here are some things that should be considered to help make the best decision possible.
1) How much additional monthly cash will my consolidation make available?
This is based on an assumption on why people consolidate, but I assume it is because the total amount of your monthly bills is more than you can afford or want to pay each month. Whatever the reason, how much cash your consolidation frees up should be a consideration if you do it or not. If the total of your monthly bills is currently $1,000 and after the consolidation your monthly payment will be $975, then the consolidation is probably not the best idea. Now if that payment is going to be $500 after the consolidation, then maybe it is worth it. There is no one number that makes this answer right, totally personal choice. Just make sure that you review all of the terms and that over the long haul you are not paying a whole lot more than you would have before the consolidation.
2) Can I consolidate without consolidating?
Is it possible that you can consolidate your bills and pay them off quicker without the formal consolidation? This requires an analysis of your bills, the amounts owed to each, the minimum monthly payments, and how much longer before they are paid off. It may make more sense to endure the high payments for a few more months, if you can make minimum monthly payments on most bills while overpaying on one to pay it off. And repeating this process until, in theory, you are debt free. This is commonly referred to as the “snowball effect,” which basically means as you pay off one bill it frees up more cash to increase the payments on another bill. This is done over and over until all of the bills are paid. I am sure there are places online that have calculators that can help you perform this task as well as Microsoft Money and Quicken. I have used both of these programs and they both are helpful in graphically laying out what extra payments can do.
3) What am I prepared to change in my spending habits?
This is probably one of the most important questions to ask yourself, what will I do differently after the consolidation? You must take a long, hard look at your financial situation and determine how you will control your spending habits differently. I hate to make it seem as though consolidation is a bad thing because it truly is not. But I do realize than many people consolidate loans and bills due to being overextended. If you fall into that category, make sure you are doing what is necessary in terms of spending controls to prevent the need for more consolidation in the future. Statistics will easily show that there is little change after the consolidation which leads to further consolidation in the future. Don’t be a statistic!
4) How much does my consolidation cost by the end?
This is really a combination of what are the terms of my consolidation loan versus the current terms of my loans. I guess it could be summed up as reading the fine print. These lending companies like nothing more than to get you into long term contracts with low monthly payments that last forever. The first several years of these payments the interest portion is far higher than the principal with statistics showing there will be some other type of consolidation after a few years. To them that is more money, more money, more money. Look at the terms of your loan and try to avoid adjustable rates, extremely long terms, or high closing costs to acquire the loan. The most important is the rate and if it adjusts. Sometimes they are unavoidable, but that makes your payment for the future unpredictable. If may only fluctuate a little at a time, but over the course of a year or two, your payment could be drastically different. The documents that you have to sign to acquire the loan will usually state how much you will pay in total if you make your minimum monthly payments for the duration of the loan. Look at this number and see if you can make it lower and meet you current cash needs. You will thank yourself in the long run.
5) What effect will extra payments have?
Consider extra payments each month, even if it is as little as $25. This makes a significant impact to the length of the loan. Obviously the amount of the loan will make a difference as an extra $25 against a $1 million dollar loan does not have that great of an impact, but extra payments help. Banks calculate payments and interest using compound interest meaning that they do not simply multiply you loan times the finance rate for the year to get your interest. They calculate it daily. So 5% per year is not $100 X 5%, it is ($100 5%/365)* 365. This gives a number much different than $105. By making extra payments you are reducing the amount by which the interest is calculates against. So everyday after you make your extra payment, the amount the interest is calculated against is lower. Makes a difference. Do the math.
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