What is debt consolidation? And is it right for you?
For many, managing and reducing debt is a popular and important goal. It’s such a big goal, however, that it can be difficult to identify tangible steps to make that goal a reality. In this vein, Dr. Dave Yeske spoke with ABC 7 On Your Side’s Michael Finney to share his thoughts on debt consolidation and other best practices for paying off debt. We share Dave’s ABC interview below along with a transcript of the conversation and additional information from Dave about debt consolidation.
ABC 7 On Your Side Video Interview
Michael Finney: I’m here with financial planner and Distinguished Adjunct Professor at Golden Gate University, Dr. David Yeske. He is one of the most influential people in the financial planning profession so there is really nobody better to go to than you. So, what is debt consolidation?
Dave Yeske: Debt consolidation is a process where you take a variety of different obligations and you bring them together under a single loan – preferably with a lower payment but most especially with a lower interest rate – which then would allow you to retire that debt more quickly.
Michael Finney: The problem is, if you’ve got a whole lot of debt, there isn’t anybody waiting out there trying to give you another loan – is there?
Dave Yeske: Well, it depends. The strategies you follow are going to be a function of your credit rating. If you go to a debt consolidator or if you to go to a bank to get a personal loan, you will get a lower rate if you have a high credit rating, and you will get a higher rate if you credit is lower – that is definitely a factor. The other thing is that when we talk about credit cards, for example, one of the simplest strategies is doing the zero-interest rate balance transfer, if you qualify for it. A lot of people don’t realize that their existing credit card company may be offering an option like that. It’s important to log on and actually see what offers are available. But you can also get personal loans from various companies including your regular banks; they offer loans that can be used for credit consolidation.
Michael Finney: I assume you would tell anyone that if you could get a 0% loan, you should be transferring your money over there and start paying it down rather than staying with your credit card with 24% or 27% interest.
Dave Yeske: Right, but there is a risk. If you transfer to a zero-interest credit card with the idea that you are going to use that opportunity to pay it down or pay it down faster, that’s fantastic. But you have to look at how you got into trouble in the first place. If you’ve had spending issues – if you haven’t been controlling your spending very carefully and if you haven’t been budgeting – then you can almost get into more trouble because you transfer to a new zero-interest credit card and then run your old credit cards back up again.
Michael Finney: So, who should do it, and who shouldn’t?
Dave Yeske: Anyone who qualifies for a low or no interest rate loan that is big enough to bring all of their other debts together, whether it’s a car loan, student loan, or credit card – that’s a very common one, obviously, with a very high interest rate. If you qualify for one of those loans, do it, but be disciplined. If you think you have a spending issue and you think you’re going to run the balance up again, that’s another issue. And you may want to consult with a credit counseling agency about developing better spending and debt management habits.
Michael Finney: So, if you’re worried you that have a spending problem, you need to deal with that before you start thinking about how you’re getting out of debt.
Dave Yeske: Yes, exactly.
More from Dave on Debt Consolidation
Debt consolidation is the process of “consolidating” numerous debts into a single loan with a single payment. Ideally, the payment would be lower, but most importantly, you want to have a lower interest rate than the rates on the loans (including credit card balances) that are being paid off. Bringing your obligations together under a single payment at a lower rate of interest means that you can retire the debt faster and at lower total interest cost.
The simplest example of this is transferring one or more credit card balances to a credit card offering a promotional zero-interest balance transfer offer. Since credit cards charge interest rates as high as 30%, transferring your balance to a zero-interest card means that the same payment retires principal at a much faster rate.
Banks and other financial institutions also offer personal loans that can be used to consolidate other loans – credit cards, car loans, student loans, etc. – at varying rates, depending on your credit score. This brings up an important point: the ability to make this work will, to some degree, be dependent on your credit score, those with high scores will be offered low rates and those with low scores will be offered high rates, or not qualify for a loan at all.
It’s important to look at the rate you’re paying on a consolidation loan, not just the payment. In some cases, the consolidation loan may have a higher rate than the debts being paid off but a lower payment because the loan is being amortized over a much longer period. What this means is that, while one’s budget may look a little better in the short run, it will take much longer and cost much more interest to retire the debt.
Another potential pitfall involves spending behavior. If one has run up a bunch of expensive debt because of a one-off event, like a medical emergency, then consolidation is a good solution. If, however, debt is out of control because of poor spending behavior, the risk is that one transfers all the credit card balances to a personal loan and then runs up the credit cards all over again. At this point, you’ve simply doubled your debt load and are far worse off than when you began. So, if someone has gotten in over their heads because of poor spending habits, they should consider consulting with a credit counselor or CFP who can help them understand and modify their spending behavior to be much more sustainable.
For those who are in over their heads and don’t qualify for a low-interest personal loan or zero-interest promotional credit card offer, debt restructuring may be the only option. This is a process where the individual works with a credit counseling agency to negotiate lower rates and a fixed (structured) repayment plan to get the cards paid off. Often, this takes the form of a single payment made to the restructuring firm or agency, which in turn pays the credit card companies. One consequence of this approach is that your credit card accounts will all be closed. This can be inconvenient but avoids the trap of transferring balances and then just running them up again. This is the option for those who don’t qualify for any consolidation options but would like to avoid bankruptcy.
When seeking help from a credit counseling office, one should seek out only the non-profits.