Keys to successful debt consolidation
Rolling payments into single loan or credit card at lower rate helps
When your personal finances teeter on the brink, your first instinct might be to do something drastic. Freeze your credit cards in a block of ice. Vow to never eat out again. Forgo your Netflix subscription.
These tactics may help, but financial experts say paying off debt requires a more comprehensive plan. One common strategy is debt consolidation, rolling multiple debts into a single loan or credit card at a lower interest rate.
“Consolidating debt into one spot can be empowering and helpful from a psychological standpoint because it feels manageable,” says Mathew Isaac, associate professor of marketing at Seattle University’s Albers School of Business and Economics.
But debt consolidation is not a solution for everyone.
Consolidation works best for high-interest-rate debts such as credit cards.
People whose income and expenses won’t allow them to resolve debt problems through consolidation or credit counselling should consider bankruptcy, says John Rao, an attorney at the U.S. National Consumer Law Center.
Consolidating your debt is only the start of a long process. Here are four keys to making it work. Budget “In order for consolidation to work well, there has to be a clear plan of attack,” Isaac says.
A basic budget allocates money for debt payments, an emergency fund and contributions to retirement savings.
But that isn’t enough when consolidating, says Lara Lamb, a certified financial planner at California firm Abacus Wealth Partners.
Successful budgeters avoid adding debt by accounting for infrequent expenses, such as car registration fees, as well as times of the year when expenses run high, like the holidays, Lamb says. They also leave room for fun. “People will go on a spending ‘diet’ and then feel like they’ve restrained themselves for so long that they go out and splurge,” Lamb says. “A realistic budget gives you enough to spend on things you value and you love.” Quit the cards Acardinal rule of consolidation is not using your credit cards as you pay off debt. People cut up their cards, lock them away or freeze them in ice, methods that seem extreme but experts say can be effective. Such tactics are known as “commitment devices” and help people achieve longterm goals, says Rebecca Rouse, di- rector of the Financial Inclusion Program at Innovations for Poverty Action, a U.S. non-profit that has done research on debt repayment. Locking away cards doesn’t mean closing accounts, which could hurt your credit. The one exception to the no-use rule is a nominal charge on your card every few months — paid on time and in full — to keep the account active and your credit intact, says Shawn Tydlaska, a certified financial planner at California firm Ballast Point Financial Planning. Compare products Balance transfer cards let you shift over debts from other cards and charge no interest for a limited time — the best ones offer from 15 to 21 months — after which a double-digit interest rate kicks in. Most cards charge balance transfer fees and require good credit scores and high incomes to qualify.
To improve your chances of getting one, add up all potential sources of income and list that total on your application, not just your salary, Tydlaska says.