Should You Consolidate Your Debt?

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Dear Carrie,

With five credit cards, student loans, a car loan, and a few other debts, I feel overwhelmed. I know everything and have good credit, but just keeping track of all payments is a problem and constantly stresses me out. Most of my debt is already automatically paid, but I would like to consolidate my debt to make things more manageable. Is it a good idea?

-A reader

Dear reader,

Borrowing money is quite easy. Paying it off is the hardest part. And yes, managing multiple payment amounts and repayment schedules is stressful. It is one of the hidden “costs” of borrowing that affects millions of Americans.

Debt consolidation could help you manage by streamlining payments and simplifying accounting. It may reduce your stress, but it won’t reduce your debt. You are still obligated to pay the money you borrowed. That’s not to say that consolidation isn’t a good idea. But before you do, there are few things to consider.

Try these pre-consolidation moves

Managing current debt is one thing, making sure you don’t get into more debt is just as important. So first, take a step back and see how your expenses compare to your income. Are you spending too much? If so, try to re-prioritize and make changes to your budget before consolidating.

If it’s just a matter of monthly management, there are a few things you can do on your own. For example, try to contact your creditors. You may be able to negotiate lower interest rates or change payment due dates, which will help you feel more in control.

Talking to a credit counselor can help you put your debt in perspective and find management techniques.

If you choose to consolidate, look beyond the monthly payment

Consolidation means contracting a single loan to repay several loans. On the plus side, this means a one-time payment at a possibly lower interest rate with a corresponding lower monthly obligation. This can give you more wiggle room in the short term, but it could also extend your repayment date, thus increasing the interest you pay over the life of the loan. So look at the big picture.

The terms of a consolidation loan are important and depend on several factors, including your credit rating, the debt security, the amount you are borrowing, and current interest rates. Then there are things like balance transfer fees, closing costs, and total interest paid. These can in fact add to your debt.

Simplifying your finances and freeing up monthly cash can be an interesting compromise. On the flip side, the full cost over time might not be worth it. Make sure to shop around for the best deal possible.

Carefully assess your consolidation options

There are several ways to consolidate all of your debts into one. But like anything else, there are pros and cons to each and the choice for you depends on your schedule and how much risk you are willing to take.

  • Balance Transfer Credit Card– The easiest approach for credit card debt is to transfer multiple balances onto a single low interest card. The advantage is that you only have one payment; the downside is that there is often a balance transfer fee and possibly an annual fee.
  • Personal loan without guarantee– Offered by banks, credit unions and online lenders, no collateral is required for this type of loan. Your creditworthiness is the key to getting the best deal. Interest rates are generally fixed and repayment terms can be flexible. But beware of origination fees and prepayment penalties.
  • 401 (k) loan—Because there is no credit check and interest rates are generally low, a 401 (k) loan may make sense in some circumstances. But it is not a risk and cost free option. First, you borrow for your retirement. Plus, you risk having to pay taxes and penalties if you don’t make your payments on time. Finally, if you quit your job, you may have to pay off the entire loan within a very short period of time.
  • Home Equity Line of Credit (HELOC) –The low interest rates can make this an attractive option for homeowners. However, interest on HELOCs used to repay debt is no longer tax deductible. Plus, refinancing unsecured debt like credit card balances with a secured home equity loan comes with inherent risks. If you are late to make the required payments, you could lose your home.

Beware of debt settlement scams

People in debt are prime targets for scammers, so beware of any debt relief and credit repair offers, especially those that offer debt relief or debt settlement. These programs are different from loan consolidation and are often scams. A big tip is if you are asked for money in advance.

Typically, a debt settlement company recommends that you stop debt payments and put money up front into a special account, which will be used to attempt to negotiate with your creditors. The catch is that while you might think that making a deal with a debt settlement company can get you through the hook if you miss a payment, interest, fees, and penalties can. again be added to the main. In addition, you run the risk of creditors hiring debt collection agencies.

On top of that, missed payments will show up as a negative transaction on your credit report, making it harder to get credit in the future. Even if a creditor agrees to accept less than the total amount owed, it will still affect your credit score.

Pay special attention to student loans

There is a whole different set of issues with student loan consolidation. And having multiple student loans, federal and private, makes consolidation more complex. Pay special attention here.

For example, Federal Direct Consolidation Loans are only available for Federal Student Loans. They won’t necessarily reduce your interest, but can make payments easier with fixed rates and longer repayment periods.

On the other hand, private consolidation loans may offer lower interest rates (fixed or adjustable), but do not have the same protections as federal loans, such as income-based repayments, abstention and surrender. The loan may also include additional fees and costs. And once you refinance the federal loans to a private loan, you can’t convert them back to a federal student loan to get the benefits of the federal program.

Manage in the short and long term

When you focus on managing your debt, also take a look at your big financial picture: your budget, your goals, and your plans to achieve them. Consolidating loans might help you manage your debt better now, but be sure to think about the long term as well, which hopefully includes controlling debt in the future.

Have a personal finance question? Write to us at [email protected]. Carrie can’t answer questions directly, but your topic may be considered for a future article. For questions relating to the Schwab account and general inquiries, contact Schwab.

Disclosures:

The Charles Schwab Foundation is a private, not-for-profit 501 (c) (3) foundation that is not part of Charles Schwab & Co., Inc., or its parent company, The Charles Schwab Corporation.

The information provided here is for general information purposes only and should not be construed as an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Every investor should review an investment strategy for their particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to changing market conditions. The data contained in this document of third-party suppliers is obtained from sources believed to be reliable. However, their accuracy, completeness or reliability cannot be guaranteed.

COPYRIGHT 2020 CHARLES SCHWAB & CO., INC. SIPC MEMBER. (# 0421-1PXP)

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