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This article is about debt consolidation, how we get into debt and some of the potential steps we can take to reduce the impact of the existing debt that we currently have.
Many of us can identify with the statistics that are in the news these days regarding the increasing debt load of Americans from all walks of life. The simple fact is that the financial industry has loosened the credit strings and we have absorbed increasing levels of debt without giving much thought to the long-term implication of the debt load we are carrying. Credit cards are easy to obtain and the credit card companies automatically increase the limits once we demonstrate that we are good customers. Car loans and mortgages are also generally easy to obtain as long as we can show that our credit rating is intact and we have dependable employment
Consider that many Americans have a mortgage on their home, a car loan, and several credit cards which are up to their limits as well as store credit for those new appliances, clothes or expensive toys that we all love and cherish! It is not uncommon for our debt to be anywhere from $10,000 to even as much as $50,000 in high interest debt on credit cards and department store credit, not including our monthly mortgage payments. If you happen to be 40 something plus with this debt and entertaining the idea of paying for your children’s education, buying a vacation property and retirement either intentional or forced, you may be wondering how you are going to meet all of the obligations that you have?
There are many solutions to this conundrum that many of us are facing, however in this article we are going to focus on debt consolidation which can have both near term positive benefits as well as longer term impacts on our overall debt / savings ratio. The fundamental principle of debt consolidation is to bring all of your debt together under one low interest loan or mortgage and reduce the total monthly payments that you are currently making to the bank, credit card companies and other institutions that you owe money to. The savings from debt consolidation can be used for further debt reduction, other debt or savings!
One of the best ways to illustrate is by example. The numbers we will use are for illustration only, however you can follow the same steps with your own finances to understand the potential impact on your personal situation.
First we need to add up all of the debt and monthly payments we are currently dealing with. Our fictional consumer has a $100,000 mortgage, a $7,000 car loan and two credit cards that have balances close to the maximum at $4,000 and $3,000 each. Current monthly payments are approximately $591 over 25 years with a 5% interest rate for the mortgage, $142 over 5 years with a 7% interest rate for the car loan, $101 over 5 years at 16% interest rate for the first credit card, which is a bank credit card and $98 over 5 years for a 28% interest rate for the store credit card. This totals $934 a month for our fictional consumer. Note that this is a simple example, however the concept is to add all of your debt, add your monthly payments and take note of current interest rates and terms for your existing debt. Total debt for our fictional consumer is $114,000 and monthly payments of $934 per month!
Most consumers have unused equity in their homes due to the appreciation of their homes during the years that they have enjoyed living in them. A house purchased several years ago could be worth many thousands more today than it was when it was originally purchased. Consumers who will benefit from debt consolidation can consider refinancing their existing mortgage in order to consolidate all of their high interest loans and credit cards. Refinancing may cost you something however it can still be worth it. The cost of refinancing typically will include an appraisal fee for your home, mortgage administration refinancing fees and legal fees. These fees can vary a lot, however consumers can sometimes negotiate with their mortgage lender to absorb some of these fees.
For the purposes of our fictional consumer, we are going to assume that it will cost them $1500 to refinance and well add this to the current debt for financing purposes for a total of $115,500. Consumers may also consider a debt consolidation loan for smaller amounts following the same principles without the need to refinance a mortgage and associated bank fees. It is important to negotiate lower interest rates than what you are currently paying and to lengthen the term as long as possible to decrease your monthly payments.
A new mortgage of $115,500 over 25 years at the same interest rate of 5% will cost approximately $682 a month or a savings of $251 a month compared to the original amount the consumer was paying. If you are fortunate enough to reduce the interest rate you can save even more money per month and you begin to see these savings immediately!
Your consolidated savings can be used to further increase your monthly payments and pay your debt off more quickly, or be assigned to savings or towards other bills you may have. Many consumers will pay themselves first by placing these funds into a savings account or into a 401k for their retirement years. Starting early with a 401k can make a huge difference in the amount of funds you have available for retirement!
We have focused on consolidating existing mortgages, loans, and credit card debt as a means to accomplish debt consolidation. Other steps that consumers may take involve evaluating all of their monthly expenses and determining which are necessary, can be reduced or eliminated. Any savings in this area can also be applied to your current loans etc until such time they are completely paid.
An expense analysis is another great way to get a handle on your debt and your cash flow. Cash flow is often one of the major contributors to financial problems were consumers just do not have sufficient funds to meet all of their monthly obligations. One approach is to create a list of monthly expenses either on paper or in an excel spreadsheet and total all of your monthly expenses. You can use the spreadsheet to add up your expenses and determine your total savings easily and quickly. Next step is to assess each expense area to determine if any reductions can be found. Examples include reducing your extra cable TV specialty channels, eating out less each week, turning the thermostat down in the winter and up in the summer by one or two degrees to reduce your energy costs, taking the bus to work, car pooling, taking your lunch to work, finding a better telephony/mobile communications package, etc. A simple analysis will uncover many potential savings areas and potentially save you hundreds of dollars every month!
Once you have your debt situation under control, the next step is to maintain your debt in manageable situation. Many financial institutions use a yardstick of somewhere between 30% and 40% of your monthly income to cover all principle, interest and tax payments. Maintaining your debt payments in this range or below will ensure that you are not at risk of being unable to meet your monthly obligations.
Paul
Richardson is a freelance writer and contributor
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