Dear Lifehacker, I've racked up a fair bit of credit card debt, and while I'm slowly paying it off, it's a pain wrangling multiple bills with different interest rates. My credit union is offering debt consolidation loans with a lower rate than any of my cards — should I take that, use it to pay off all of my cards, and only have one, low-interest bill to pay every month? Thanks, Trying to Dig Out
Picture by Joe Raedle/Getty Images
Dear Trying to Dig Out,
It's tempting, isn't it? Getting rid of all of your credit card bills, no more annoying multiple payment to multiple creditors, just one, automatic loan payment every month and you're back on the road to being debt free, right? Well sure — but there are some caveats that might sour the milk for you. Let's explain, and then you can decide whether it's a good idea in your case.
When Debt Consolidation Loans Don't Make Sense
In many cases, debt consolidation loans don't make sense. They're certainly attractive: the lure of being able to pay off all of your credit cards is a strong one, especially in exchange for a single monthly payment to your bank or credit union at a lower interest rate. It's definitely a tantalising opportunity, but it's not perfect. Remember, debt consolidation loans are financial products, which means financial institutions wouldn't offer them to you if they didn't make money from them. Here are a few tips to make sure you're not falling into a trap:
- Do the maths on your credit cards and their interest rates, and figure out how long it would take you to pay them all off at your current payment rate. Compare that to the length of the consolidation loan you're looking at taking out. Your average five-year (60-month) debt consolidation loan, even at a lower interest rate than your credit card, may cost more over the long haul than if you just paid your cards off.
- Check what your monthly payment on a debt consolidation loan would be. Are you at least paying that much towards your credit cards now? If the loan payment is more than you pay towards your debts (and it fits into your budget), it might be time to up the ante and just put more money to your credit cards. If the loan payment is less than you pay to your cards, you'll wind up paying way more interest over time, since your loan term will be much longer.
- Once your cards and debts are paid off, will you cancel the credit cards? Sure, you get credit cards with zero balances and no bills out of the loan, but one of the biggest problems with debt consolidation loans is that they do nothing to change the behaviours that got you into debt in the first place. Instead, they add another creditor to your pile, and fan the flames of going into debt to pay off more debt. If you even think you might be tempted to use those cards again after paying them off, or if you're using debt consolidation as an easy out or way to avoid really looking at your budget, it's not right for you. The last thing you want is to take out a loan, pay off your cards, and then charge up your cards again — now you've done nothing but dig your hole twice as deep.
When Debt Consolidation Loans Make Sense
If you're hopelessly drowning in debt, know that you can't negotiate any lower interest rates with your credit card companies or creditors, and if the maths works out, a debt consolidation loan may be a good decision for you. Similarly, if you're in serious trouble with high interest rates, high monthly payments (that you're having trouble with already), and too many bills, a debt consolidation loan might help. Combined with a debt repayment plan and credit counselling, it can be used to pay off all of your debts at a fraction of their original cost. Photo by erules123.
Of course, those situations aren't the norm, and most of us with credit card bills looking to get rid of them aren't in that position. That's not to say there aren't situations where debt consolidation loans can offer people who really need them the breathing room to get out of debt and organise their finances. But you need to check the details carefully.
It All Comes Down To Mathematics And Behaviour
It may seem attractive to just take out a nice big loan, pay everyone off, and only deal with that one monthly loan payment, but all you're really doing is paying a financial institution to do something for you that you can do on your own. It feels great not to get a bunch of bills in the mail or fret over who you pay when and how much, but you can do the same thing on your own: Photo by Media Bakery13 (Shutterstock).
- Start by creating a realistic budget.
- Then decide whether you want to pay highest interest cards first or lowest balance cards first.
- Set up auto-pay so you're paying more than the minimum payments every month, paperless billing so you don't get the bills in the mail (although you should still review them every month), and let your money manage itself.
Remember: even if the maths of a debt consolidation loan works out in your favour, your behaviour is the real problem. Paying off all of your credit cards and debts with a loan only shuffles the deck chairs around — you still owe money you have to pay, and if you go charging up those freshly paid-off credit cards again, those deck chairs may as well be on the Titanic.
Make no mistake: if you want help with your debt, you should get it. Don't let social stigma or ego get in the way — there are plenty of ways to get on the right track that go further than blog posts and stop short of putting you back in debt to someone else. Debt repayment and credit counseling programs can negotiate lower interest rates on your behalf, or help you do it yourself. They can help you with your budget, and help you plan a route out of debt that turns your credit into a tool you control, as opposed to a monster than controls you. If you need the help, get it — and definitely do that before you take out a loan.
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