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The Inside Secrets
of Debt Consolidation
In a typical debt consolidation example, a lot of different bills are squished together into one monthly payment. The big attraction for using this strategy is that the single, monthly payment is less than you would normally be paying on the debts individually. Also, making one single payment can be more convenient than making several different payments.
Now the bad things to consider. Let's say you have chosen a debt consolidation company to go with. Whenever you give up responsibility over a situation, you also give up control over the situation. What happens when this company does not make one of your payments? It is still your credit that suffers!
More predatory consolidation companies will figure out your total monthly payments, add an extra payment for themselves as payment for their services, and will take this fee from the first payments you make to them. By the time you realize that none of your bills during this first month have been paid, the debt consolidation company will already have made their money and the damage to your credit will have already been done. The lesson is to carefully read the contract of any consolidation company you are considering using.
How Debt Consolidation Works
To Lower Your Payments
Debt consolidation is not a magic solution. Whenever you lower your monthly payments, you extend the time period over which you will be making those payments as well as the total interest you are charged. By taking a group of payments and making it less, you will be forced to make payments for a longer period of time.
As you can see from the mathematical example below, debt consolidation is not a good option for anyone actually trying to get out of debt. In the long run you pay a lot more than you originally would have. Consolidation is good for the consolidation company, it is good for us (because we make a referral fee), but it can only benefit you if you use the correct strategy. The best strategy is to secure your small window of opportunity, and than make sure you do not blow your opportunity. This means cutting your expenses to the bone and using your time wisely to change your focus through financial education.
Debt Consolidation Example
Let's say you are struggling to pay off $33,000 in unsecured debt. The debt consists of a 2 year loan for $12,000 with a 12% interest rate, and a 4 year loan for $21,000 at a 10% interest rate.
Your monthly payment on the $12,000 loan is $539 a month. The payment on your $21,000 loan is $595 a month. Your total payments before consolidation would be $1,134 per month.
After carefully comparing debt consolidation companies and reading their contracts, you choose a company and give them your information. By negotiating with your two creditors, they tell you they have been able to lower your monthly payment to $670 per month. They also have been able to lower your interest rate on the loan to 9% by combining both debts into one loan.
When presented in this way, the offer sounds fantastic. Very few people feeling pressure from their financial problems would be able to resist the offer to pay $464 dollars less each month. In order to make this possible, you will have to make payments on the new loan for 6 years to pay it off. When you are actually in the financial pinch, this offer doesn't sound that bad…until you do the math and realize how much more in total you will be paying.
In spite of the fact that you received a lower interest rate, your new debt consolidation loan will cost $48,200 to pay off, as opposed to $41,957 for the total debt on the original loans. So, in the long run you pay an extra $6,243 to pay off your debt in exchange for the convenience of having a smaller payment to make each month. If your focus remains on earned income and expenses, you will be forced to control your spending habits for an additional two years while you finish paying off your new loan.
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