Debt has a way of getting away from you. Aside from normal lines of debt like a mortgage or credit cards, parents accumulate debt from the health care costs of their children and unplanned for events, particularly if they don’t have an emergency fund with enough money to cover such an emergency. More and more parents today are still burdened with student loan debt, which can be very difficult to get around.
Consolidating your debt means combining all the accounts that you pay on monthly into one payment instead of paying each creditor independently, which can save you money on interest and make paying your debt much less complicated. There are a couple of different methods of consolidating your debt and as with all personal finance decisions, what’s best for your family and situation might not be what’s best for someone else.
The most important thing to remember when considering your options for debt consolidation is that you don’t want to go further into debt to do it.
As we will discuss, some methods for consolidating debt can actually add to the amount of money that you owe. Be careful to avoid these. The right option will be the option that simplifies your debt repayment and saves you money over the course of the loan with a reduced interest rate or other benefits.
All debt is not created equally. Debts associated with property, such as a mortgage, usually qualifies for lower interest rates and look better on a credit report. A mortgage is secured debt, which means that the amount of money that you owe directly relates to a piece of property worth (hopefully) that value or more. It’s a secured debt because if you fail to pay it, the bank could seize your house for the value you owe. Other forms of secured debt is a automobile loan or a loan to pay off a big ticket item such as an engagement ring. Unsecured debt is a trickier beast. Unsecured debt means that there is no property directly correlated with the loan, or nothing to be seized if you fail to pay. Student loans and credit cards are examples of unsecured debt.
When a lender is giving money for a secured debt, they have a reasonable level of guarantee that they will get their money. If all else fails, they have the ability to take the property that secured the loan. Due to the fact that this does not exist with unsecured debt, lenders make up the difference in risk by charging more money for interest. That is one of the main reasons that the interest rates on credit cards is so much higher than the interest rates on a mortgage.
Strategies for consolidating debt range from remortgaging your home to opening a new credit card. Depending on the level of debt you owe and how much you plan to consolidate, the plan that is best for you will vary. Some of the easier ways to consolidate your debt is by looking at your credit cards, student loans, and mortgage. In some cases, credit counseling is the best course of action.
Credit cards are the most common unsecured debt. The high interest rates associated with credit card accounts are a compelling reason to want to consolidate and minimize these debts. There are two main ways to achieve this goal.
With a personal loan, you can take out enough money to pay off all of your credit card accounts, leaving you with one monthly payment to the bank instead. This is a smart choice if you can find a loan with a lower interest rate than you are currently paying on your credit cards. The downside is that a lower interest rate can be difficult to find if you owe a substantial amount of money in credit cards.
If you have multiple credit cards, you can consolidate the accounts by transferring all your balances onto one card, called a Balance Transfer. This option is really great if you open a new card and have a period of time before you have to start paying interest on the balance. In that period of time, every payment you make will be essentially interest free, even if that debt has sat on your old card for a long period of time. Sometimes this is just enough boost that people need to get on top of their payments. But beware: if you don’t make progress on the amount you owe before that introductory period expires, you could have one very large payment on your hands.
Student loans through private companies can often be treated a lot like a credit card line. Student loans issues through the federal government are a little bit different, and options will be limited depending on who your lender is. For the most part, there are two ways of consolidating student loans debts.
Most student loan debts can be consolidated and refinanced into one loan, particularly if you have several debts to one institution. Federal loans can also be consolidated, and often offer the best interest rates available on the market. By putting all these debts into one account, you can make payment arrangements based on a longer period of time, which means a smaller interest rate although a larger lifetime payback amount.
Income Based Repayment
All federal loans offer an income based repayment option, where you pay a certain amount based on the income information you can provide the lender. Income Based Repayment is a much better option than defaulting on your loans because you are unable to make the payment, but it doesn’t do anything to change to structure of the loan. In other words, you’re paying less money per month, but you’re also making less progress on paying off the loan. If you can’t afford your payment, income based repayment is a great tool, but paying more per month on student loans will save you money over the course of your lifetime.
Secured debt can be used as a tool to consolidate unsecured debt, and that involves understanding the equity of your assets. One way of thinking about equity is, if you were to sell your asset (your house, for example), equity is the amount of money you would have left over after you paid the bank what you owed on the loan. Owing $75,000 on a home worth $100,000 means that you have $25,000 worth of equity on that loan.
Lenders will give you money secured against equity in the form of second mortgages or remortgages. While it can be an incredible tool for consolidating debt and saving money on interest, remortgaging should not be taken lightly. Equity is not something that is easy to build and you’ve likely worked very hard for it. However, because mortgages tend to require a much smaller interest rate than credit card debt, moving your debt into your mortgage can save a ton of money over the life of the loan.
In some cases, there is no option above that doesn’t result in owing more money in the long run. Generally, those are situations where your family is seriously and deeply in debt. When this is the case, the smartest thing to do is to contact a credit counselor or counseling agency to help make sense of your debt.
Credit counseling agencies manage your debt for you. You pay them one monthly amount, and they pay each individual account for you. They work with you to set a budget and you pay them as much of your income as you are able to, and they decide how the money is best used to pay your debt. This is an extreme option, but it can be a lifesaver for people who struggle to make sense of which financial strategy they should be using.