Does Debt Consolidation Make Sense?

If you are like most Americans, your mail box is filled with offers for credit cards, mortgage refinancing, and home equity loans. Many of those offers stress the benefits of moving existing balances to the new lenders. While that may sound appealing, especially if the new loan offers an attractive initial interest rate, it is important to consider all the factors associated with debt consolidation.

Debt consolidation is debt management, not debt elimination

Moving all your outstanding loan balances to one lender will not reduce the amount you owe. You must ultimately pay off the loan and pay interest until the loan is repaid. Your goal should be using debt wisely. Consider the following steps:

Paying down your credit card debt

Even if you have not borrowed the maximum allowed for your credit card, paying down your balance should be one of your top priorities.

• Pay more than the minimum on your credit card balance. Interest rates charged on most credit cards are usually much higher than those found on other loans.
• Make your credit card payment as soon as you get the statement. Doing so will help reduce the interest you are charged.
• Minimize your credit card usage for a period. Along with not subjecting higher balances to interest, using cash or a check card may help you identify ways to spend less.

Evaluating the real estate based alternatives

Start by reviewing the interest rates on your existing debts. Credit cards and unsecured personal loans usually have higher interest rates than other forms of secured debt like a mortgage, home equity loan or an auto loan. If you find that your rate on a home equity line of credit is less than the rates on credit cards, other personal loans, or auto loans, utilizing borrowing through that line of credit may save you money.

Then evaluate your borrowing capacity available through a mortgage or a home equity loan. Borrowing through a shorter-term home equity loan will probably lower your interest rate, but most home equity loans have variable interest rates. If you have a great deal of high interest rate debt, refinancing your unsecured debt into a new fixed rate mortgage (even if you end up with a slightly higher mortgage rate than what you currently have) may result in lower overall interest costs. The interest you pay on your mortgage or home equity loan is also tax deductible if you itemize your deductions.

Final words

• Discuss your situation with your relationship banker. They will be able to explain the alternatives and help come up with a solution that’s right for you.
• Evaluating these real estate based alternatives can be complicated and may involve risk, so discuss them with a financial professional.
• Use common sense. Remember borrowing money means you have to repay it. If your borrowing is too high, take immediate steps to reduce it. Every dollar of debt reduction will translate into less interest you have to pay.
• Seek a credit counselor if you need help. There are many organizations that help consumers when all else fails. The Federal Trade Commission offers facts for consumers to consider when choosing a credit counselor. Among the most important are to be very wary of any organization that wants you to pay a fee for their services or that promises an easy solution to your situation. If their message sounds too good to be true, it probably is.