Friday, October 28, 2016

How I Got My Finances in Order part 7 Should I Get A Consolidation Loan?

Do You Want To Get A Consolidation Loan?

Once I came to terms with my debt problem, I had to figure out what strategy I would use to deal with it. I had three major options. Many people stop using their credit cards and just pay off as much as they can each month. They tend to use the snowball effect. You pay off the smallest balance first and then work your way through all the accounts. Using this method you keep they really high interest rates, so I didn't want to use it. Also I had been ineffective up to this point at paying bills so why should I think anything would change. The balance transfer is another tactic. You take hunks of debt from one card and sent it to another one to have a much lower or no interest. I rejected this idea for a simple reason. I had many times transferred balance from one card to another and it had done nothing to help me.

Taking out a consolidation loan is a third popular option. You see them advertised on TV and the internet.  Reduce all your high interest credit card payments to one easy payment. That basically covers the gist of what a consolidation loan entails. You take out one big loan to cover all your existing credit cad debt. You pay one place and you get a better interest rate. Your monthly payment is set and tends to be much larger than you minimum credit card payment. Consolidation loans can be a great help in getting out of debt, but they can also trap you in a cycle of debt.

What are the benefits of a consolidation loan? The biggest benefit you get is a much lower annual percentage rate of interest. My credit cards had APRs between 19 to 29%. The consolidation loan (SPOILER) I eventually got was under 9%. The total interest paid out for my three year loan was the same as I was paying per year on all my credit cards. The fact that the payment is fixed every month, and in my case auto deducted from my bank account, can be another big benefit.  You have to make the payment. With just a credit card payment you can make the minimum payment and prolong your debt and maximize the interest you pay.

You don't want to get trapped into the cycle of consolidation loan debt, which is one of the biggest drawbacks. The cycle of debt occurs when you aren't sticking to your budget or your loan payment is too large. Month by month you payment is being sent to the consolidation loan but at the same time you aren't staying in your budget. You keep whipping out the credit cards to keep up with normal expenses. So after your three or five years the consolidation loan is paid for but you are staring at another pile of credit card debt.  The loan company is there with a convenient solution, another consolidation loan. And the cycle continues until your children inherit your debt. Another drawback is the same as one of the benefits. You have to make the payment every month. You can pay more but not less. If you take out a loan with too big of payment or lose some income you can end up in a real bind.

When I was trying to decide to get a loan or not, I needed to make sure that I would not fall for any of the traps. I determined about how much my monthly payment would be. I then subtracted that from my monthly income and for two months saw if I could live within the amount left. I made the minimum payments for my cards out of the amount a deducted for the loan. I took the amount I didn't put toward the minimum payment and put it into my newly started emergency fund. For two months I managed to keep within the limits and so I decided to pull the trigger and get the consolidation loan.

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