Anna Fleet

08/14/2007

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Learn Your Debt Consolidation Options

There Pros and Cons when it comes to Debt Consolidation.

Having one bill every month instead of 6 sure sounds like a good deal doesn’t it? However when it comes to putting all of your debts under one lump payment called consolidation, you need to know the facts. Oftentimes debt consolidation offers a lower interest rate, but lower interest rates on a higher lump balance over a longer loan term (length) won’t necessary be saving you that much money over the long-term. That’s why I’d like to discuss the pros and cons of debt consolidation.

4 debt consolidation tips to remember:

1. Choose the lowest repayment term (length) possible as long as you can afford it. Sure you may have to sacrifice, but you will pay a lot less interest over time.
2. You should be working to get the debt paid off in at least 5 years time.
3. Check to see that your existing loans don’t charge huge penalties for transferring the balance of your loans into consolidation – this could really raise the amount of what you owe by hundreds of dollars.
4. Seek credit counseling. A financial professional can help you understand your options. Better yet a non-profit credit-counselor is not affiliated with any consolidation or financial company and will negotiate with your creditors on your behalf.

Ok now here are your options when it comes to debt consolidation:

Option 1 - Refinance your home

If you own a home – or part of a home – and the interest rates on your mortgage are decent – you can refinance your home and use the cash that you borrow over and above what you owe on your current mortgage, to pay off your outstanding debts.

The pros of refinancing your home to pay off consolidated debts are:

• You can deduct interest on a mortgage, but not on credit card debt.
• You can save a fortune if you own on a lower interest home equity loans; compared to a high interest credit card.
• You can put the extra money you save on interest with a home equity loan into an emergency fund that goes towards repaying your loans.

• If you’re bad with credit, suddenly you’re at risk for losing your home.
• With home equity variable rate mortgages the interest rates can fluctuate/go up.
• Consolidating your loans (putting all of your smaller loans into one large loan) will lengthen the term of your loan (length of time you will be paying it off) so realistically it might cost you more in interest rates than it would if you paid off the loans separately one at a time.
• Lower credit card interest rates are possible if you just call your credit card company before consolidating. Many companies would rather lower your interest rate if it will encourage you to pay off your debt faster.

Option 2 - Borrow on your investments to pay off consolidated debt

For instance borrow on your RRSPs (Registered Retirement Savings Plans), IRA’s or your existing stocks and bonds.

The pros of borrowing on investments to pay off consolidated debts are:

• The interest rates on loans borrowed from investments are lower than traditional consolidation loans – even through reputable banks.
• Borrowing from your investments might be your only option if you have no credit history as these are already yours to borrow from – no credit check required as with a traditional loan.
• If you borrow from your IRA to pay off a consolidated debt you can borrow with no penalties or taxes if you pay it back within 60 days.

• If you are untrustworthy with credit, remember that these investments were put away for your retirement. You don’t want to blow your entire nest egg and be left with nothing come retirement.
• You will pay a 10% plus taxes penalty if you borrow retirement funds early – even if you pay it back.
• If the market crashes you may loose your investment or have to pay huge penalties to repay the full amount. The market is unstable and sometime a “margin call” will occur if the crashes. Financial advisors will recommend not borrowing more than 25% of your investment balance for this reason.
• If you borrow from your IRA to pay off a consolidated debt – you must pay it back within 60 days or you will pay penalties and taxes on the amount owed.

Option 3 – Loan funds privately from family and friends

This can be an ideal agreement if you have a good relationship with your parents or another personal friend who is also willing to lend you money.

• Family or friends will probably offer you zero or a very low interest rate – compared to a traditional lending institution.
• The pressure to pay back a personal relation may be all you need to get you out of debt quickly.
• Look into the tax perks by consulting a financial lawyer – for both you and your private lender.

• If you are irresponsible with repayment you may lose the respect and friendship of a close family friend or loved one.
• Many won’t mix personal and business because of the pressure money puts on relationships.
Many will not even approach a friend or family member for a loan due to embarrassment or pride.
• A personal loan will sometimes cause the IRS (Internal Revenue Service) to be suspicious of your honesty come tax time, so you may be audited on both sides.

Option 4 – Borrow from a bank to pay off consolidated debt

Securing a personal loans from your bank keeps your finances just that – personal and private. It’s not like that with family and friends.

• If you’re a long-time customer your interest rates will likely be good.
• You’re bank will offer you a choice of loan options – personal loan, home equity loan, and etc.
• You can ask the bank to withdraw your loan payments automatically so you never have to remember to send a check or cash.

• If you have a bad credit history or are a new customer you may be offered a higher than average interest rate.