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Debt Consolidation Basics
Obtaining a lower interest rate If you have several loans and credit cards at varying interest rates you can obtain a single loan with a lower interest rate and use it to pay off the others. This will give you a lower monthly payment than the payment of all the original loans combined. Converting revolving debt into installment debt Installment debt or loan have a fixed payment and are completely paid off over a period of time. Credit cards are revolving debt with flexible payment terms. You can pay the minimum payment or more if you like. Credit cards also provide the temptation to use them again and make backward progress in paying off your debt. Transferring credit card debt to installment debt removes these temptations and usually forces you to pay down your balance faster. Making one loan payment instead of many Consolidating debt into a single loan makes it much more convenient to manage the loan and make sure payments are made on time. Many loans would have different due dates and payment options creating confusion and the possibly to forget a payment and further damage credit. Converting variable rate loans into a single fixed rate loan Variable rate loans or adjustable rate loans will have larger monthly payments when interest rates increase. Many credit cards are adjustable in this way. Home equity loan and home equity lines of credit (HELOC's) are often adjustable. Moving this debit into a fixed rate loan is a good idea in a period of increasing interest rates. It also removes the uncertainty of future loan payments. With a fixed rate loan you know exactly what your payment will be in the future. Converting unsecured debt into secured debt Credit cards are unsecured debt meaning that they are not tied to assets. Car loan and home mortgages are secured debts because they are tied to hard assets, cars and real estate. These can be repossessed or foreclosed upon if you fail to repay the loan. Secured debts are less risky for banks because they are tied to assets. Thus they often have lower interest rates. A common debt consolidation strategy is to pay off credit card balances using a home equity loan with a lower interest rate. This also has tax advantages (see below). Transferring debt to tax deductible debt The interest you pay on a home equity loan is often tax deductible. This means you can reduce your annual taxable income by the amount of interest you paid over the course of the year. Using a home equity loan to payoff high credit card balances will usually result in a lower interest rate and the ability to write off the interest payments. Amortizing debt over a longer period of time Loans can have different terms. Car loans are commonly amortized or paid off over 5 years. Student loans over 10 to 20 years, etc. Moving shorter term debt over to longer term debt will lower your monthly payment. This tactic has disadvantages. Longer terms mean the total sum of your payments will amount to much more and it will take much longer to retire the debt. Things to watch out for when consolidating debt. Debt consolidation companies often charge very high fees to perform the above services. They can take advantage of a customers dire situation and charge exorbitant fees. They then offer to roll these fees into their loans making it more enticing but effectively increasing the overall debt. Unscrupulous companies might also steer debt consolidation customers toward lenders that pay a kickback without the customers knowledge. The consolidated loan may not have the best possible loan terms. See Also: Resources:
Comment on this article:
I've read about the debt snowball method and it's pretty cool. A bit confusing but sounds like it would work well and relieve a little stress.
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