The Frugal Creditnista

4 Alternatives to Debt Consolidation


It is a beautiful afternoon here in Chicago, we've gotten our first sticking snow (sticks to the ground) today and it is cold!

I was asked about how to consolidate loan/credit card debt on your own this morning, so here you go!

Debt Consolidation is when you get a new loan (or line of credit) to pay off your credit card(s) or some other debt. The benefit is that you have one debt to pay each month and it's usually at a better interest rate. There's also a benefit credit-wise. If you have used more than 50% of your credit limit, your credit score is taking a major hit. By switching the type of credit from a ‘revolving' line of credit to an ‘installment' credit, you are getting your debt utilization back, which is 30% of your credit score.

Here are some ways to consolidate debt on your own:

1. Obtain a new card and transfer the balance. Example:

A client of mine had a 643 credit score. Two of her cards were almost maxed out and the interest rates on them are 16.99 and 24.99. She spoke to her current credit card provider to see if she qualified for another card and they gave her 2 options – one of which was a 12.99% credit card with 0% interest until 2015, 0% on balance transfers until the end of 2015 and the credit limit was higher. She was able to transfer the balance of the 24.99% card over to the new card, saving money, interest and her credit rating. The other card? She decided to just put more money towards it each month so that she can quickly pay it off.

2. Another Option is a personal loan or Home Equity Line of Credit (HELOC).

Obviously the HELOC only applies if you own real estate. I'm not a fan of using the equity in your home to do anything other than make other investments that will bring in a better rate of return. 

Some of my clients have had success with personal loans via their personal bank or credit union and I am a fan of this, especially with credit unions. Honestly this is the longest option because the process from application to funding can be in excess of 30 days. However, the attractive interest rates and the opportunity to strengthen the relationship with your bank makes it a strong option.

3. Peer to Peer lending. This is the 2nd quickest and a very viable choice if obtaining a new credit card is not an option. Again, I'll provide an example:

My client has 3 credit cards at interest rates of 13.99, 24.99 and 22.99. She got a peer to peer loan from Prosper and was able to get a $10,000 loan to pay off all of her credit cards at a 13.75% interest rate. See the benefit? One loan. One monthly payment. Lower interest rate. Other peer too peer companies include Springleaf and LendingClub. Another plus is that the application to funding process can be less than 10 days.

4. A more labor intensive but FREE option is to create your own DIY Debt Pay Off Plan. The other options above require credit approval and have merely allowed you to move your debt from one place to another in order to pay lower money on interest rates and to create an ease of monthly payment. But, the debt itself is still there. At the end of the day, if you are still in debt and you still owe the debt whether you use a HELOC, a peer to peer loan or a balance transfer. So, let's discuss actually paying it off.

~First you'd need to list all of your creditors along with their interest rates, balance, minimum amount due.
~Next negotiate with your creditors on lowering the interest rates, which will save you money over all. I would like to tell you that all of them will lower your rate but that would be completely misleading. Depending on your payment history, the longevity of your relationship as well as other factors, you're looking at a 20-60% chance of getting your rates lowered. 

~Now you need to create a Pay Off Plan. If paying more than the minimum monthly payment seems daunting, you need to stop here, create a budget and find some things to cut in order to put more money towards your debt (switch cable for Netflix, HULU or some other company, downgrade cell phone package, increase your insurance deductible, etc). 

~Next decide which method of payment you'll use. Some advise starting with your higher interest rate debt first and working your way down to the lowest one. Others advise starting with the lower debt first and working your way up to the debts with a higher balance. Honestly it's up to you. I've noticed that the higher interest rate cards typically have the lowest balance anyway; but do what is going to keep you motivated. For me, it's seeing something eventually get paid off and crossing it off of my account list; thus I went with starting with the lowest balanced cards first. The key to either strategy is making sure you use the funds from the paid off card to add to the next card on the list. For example, let's say you have 3 credit cards:

Visa $3000, 13%, $25 minimum monthly payment required, the amount you budgeted to pay per month is $125
Visa $5000, 10%, $50 minimum monthly payment, the amount you budgeted to pay per month is $50
Master Card $8000, 7%, $75 minimum monthly payment, 
the amount you budgeted to pay per month is $75

Once you pay off the $3000 Visa you put that entire $125 payment amount towards the $5000 Visa, increasing your minimum payment you make to $175. Get it?! So, whether you start with the lowest balance or the highest interest rate, ‘snowball' the payments to get out of debt faster.

I have both a budget template and a dept pay off template listed here. If you'd like a customized debt elimination plan that will allow you to factor in all of your debts – car, home, credit cards, etc – contact me about our DebtZero program.

Here's to being Debt Free!!!

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