Debt consolidation is often marketed as the easy way out of debt. Im sure weve all seen television advertising consisting of interviews with relieved looking couples who have consolidated their debt into one easy monthly payment, Sometimes they even have enough left over to take that trip of a lifetime, or treat themselves to something special. The truth is, that debt consolidation can often be dangerous, and far from being the way out of debt, its often one of the first steps to getting deeper and deeper into debt. As an example, let's say you owe the following on credit cards: Credit card 1: $1,000 at 15%, 2% minimum payment each month Credit card 2: $2,500 at 12%, 2.5% minimum payment each month Credit card 3: $1,500 at 13%, 2% minimum payment each monthYour total debt is $5,000, so you decide to consolidate it into your mortgage. After all, your mortgage is at a much lower APR, only 5.5%, and although you've got 25 years remaining on it, your mortgage company has told you it'll only cost an additional $30 a month, where as previously you were paying over $110 a month just meeting the monthly minimum payments. But it's not as simple as it seams. Although your mortgage is on a much lower interest rate, it's also over a much longer period of time. In fact, over the 25 years of your mortgage, you'll actually pay over $4,000 in interest on the extra $5,000. That nearly doubles the cost of your original credit card debt. Snowballing may be the answer. By snowballing your debt, you pay off your debts in order of interest rate, from highest to lowest. You pay as much as you can afford on the debt with the highest interest rate, while paying the minimum on your other debts. As one debt is cleared, you move on to the next and so on, until you've reached your debt free day (Hurrah!). In the above example, you're already paying $110 a month just to meet the minimum repayments. If you could stretch to paying $200 a month then you could be debt free in just over 2 years, and only pay around $750 of interest. That's got to be better than paying over $4,000 right? Even if you could only afford $175 a month, it'll still take you less than 3 years to become debt free. In my opinion however, there is a much bigger advantage to snowballing than just paying off your debt quicker and saving money in interest. The biggest problem with consolidation is that it can often give you the false feeling that your debts have been paid off (they haven't, they've just been moved), which can lead to building up extra debt on your now "clear" credit cards. Snowballing takes a small amount of money management - Each month you need to figure out how much to pay each of your debtors, and you need to write the cheques or transfer the money. That means that you'll naturally start to look at your finances and once you start doing that, you're well on the way to managing your money better. Money management - It really is addictive! |
