Consolidation loans are a great idea in theory. If you have a high balance of debt with high interest rates, it may be difficult to make headway against them, and a consolidation loan is often advertised as a way to lower your monthly payments. In essence, a “consolidation loan” is simply taking out a new loan for the purpose of paying off credit cards or other loans with high interest rates. Approval for this type of loan and what kind of loan terms you are offered will depend on your credit report.
Here’s how to successfully use a consildation loan to get out of debt:
- Do not use your credit cards anymore. Verify with your budget that you can afford not to touch them for your regular expenses. Take the cards out of your wallet. Depending on how much you struggle with putting them away, decide if you need to close the accounts, or cut up the cards, or freeze them in a big block of ice, or keep them at your mom’s house, etc. Get them away from you.
- Detail your debts. Add up all your debts that you’ll be consolidating, list all your interest rates, and add up what you’re paying in monthly minimums. Check your credit score, if its very low, you might have a hard time getting approved for a consolidation loan with low enough payments to help you.
- Overpay. If you are approved for the loan, continue paying that amount you got when you added up all your individual minimum payments. This should be more than the amount the loan requires, and if you were able to handle it before, you should be able to continue it now. You MUST stick to this, its your new bill, non negotiable. You can pay more than that even, if you want. But keep that “minimum” the same as your old minimums.
When you have a consolidation loan, getting rid of your debt is your number one priority, and then all that money you were paying in minimums? You just basically gave yourself a huge hundreds-of-dollars-a-month raise. It’s pretty sweet. Imagine if 5 years from now you had the same income, but NONE of the debt? You’re already living off that small amount, and suddenly all your old debt payments are available to you to save for an emergency or a new car or retirement or whatever you want! Paying off debt is one of the most rewarding things you can do for yourself.
The problem with consolidation loans is inherent in their function, they free up your credit cards.
If you’ve been using any credit card in the last 6 months to cover expenses, you are not ready for a consolidation loan. You will likely continue using your credit cards, max them out again, and get yourself double the debt.
If you do not manage a budget regularly, you are not ready for a consolidation loan. You have to know for a fact that you can make these payments without reaching for those credit cards again. This should be alongside your other goals such as building an emergency fund.
Consolidation loans are NOT good for people who are struggling to stick to a plan, or looking for some kind of cop-out instead of changing their lifestyle to be more affordable. Most of my clients are looking at a couple of years with a consolidation loan, depending on how much debt you have and how much income you have to work with.
If you have not been able to make all your minimums with your current lifestyle, check out some ways to reduce your expenses, cut your spending, or bring in some extra money.
So yes, consolidation loans can be a huge help when you are looking to change your financial circumstances, but they do not solve any of the root problems that brought you to that point. If you need help getting your budget stabilized so that you can safely consider a consolidation loan, please book a FREE consultation with me and I will help you figure out how to get your financial life on track!