The most common practice in debt reduction is to consolidate all your current debt on either your lowest interest credit card or obtain a new lower interest line of credit. This can save you a lot of money in interest charges during the time that it takes you to pay off all of your debt. Since for many this is a very important step to take, it’s vitally important that the proper research is made prior to beginning the debt consolidation. In its simplest terms, every percentage point that your debt loan has is equal to $10 in interest per $1000 in principle paid each year.
To begin, you need to compare this to the balance transfer fees for moving your balance to a lower interest card or consolidation loan. These fees are typically around 3%. That means if you’re going to pay a $1000 loan off in less than three years, it would be better to leave the money in your current account rather than pay the fee to transfer to an account with an interest rate that is 1 percentage point lower. If you can pay it off in one year, you would have to reduce interest by a minimum of three percentage points to make it worth the fee.
Almost all of the wonderful credit card offers advertising 0% interest for an introductory period come with a percentage transfer fee. If you can find one that does not, this makes for a quality way to consolidate your debt and lower your overall payments so that your can pay it off with maximum efficiency. This efficiency comes from the fact that during this introductory time, you are paying down your debt with 100% of the money that you send to the credit card company. Just be sure that you read all of the fine print and note that most of these 0% intro offers become void if you make a late payment or miss a payment.
This becomes even more important with each additional debt that you are consolidating. If you have three credit cards, a student loan and a car loan that you are rolling onto a lower interest credit card or consolidation loan with transfer fees, each of those 3% charges could add up to hundreds of dollars. This has a two fold effect as an adversary to your debt reduction goal. Not only are you now a few hundred dollars further in debt, but you are paying interest on that new debt as well. This could effectively wipe out a good portion of the benefit that this new lower interest rate provides and thus stop you from reducing your debt at the rate at which you were working hard to achieve.
Just as you should be double checking or triple checking your budget, looking for another dollar to squeeze out each month so that you can use to pay down your debt, you need to research the debt consolidation benefits with the same intensity. You are shooting your debt reduction plans in the foot if you are not being as diligent when you check on your consolidation method. The fact of the matter is that these transfer fees are how some so-called debt consolidation loans or debt consolidation plans are profitable to the advisors or institutions that offer them. As nice as these people or places may seem to be, remember that they are in business to capitalize on the fact that many people are in debt too deep and need help to get out.
If the debt consolidation interest rate is enticing, take the time to check the fine print. Especially look for other fees that are not spelled out clearly upfront. Also be careful to note if there is a prepayment penalty, the worst thing you can find in a consolidation contract if you’re trying to reduce your debt. This is a penalty for paying a loan off early, kind of like a guarantee that the borrower will pay interest for a minimum term. You will most likely want to steer clear of these in. They completely contradict the guerrilla payment strategy of sending as much money as you can each month toward the repayment of debt.
In the end, you need to run the numbers for each possible scenario to find out if consolidation will save you money. The transfer fees may not be the deal breaker if the interest is substantially lower than what you are currently paying, but you won’t know unless you do your research before making the debt consolidation move.
Working on Your Debt?
Join our FREE newsletter to get even more helpful tips straight to your inbox.