- Posted by NateKragness on October 21, 2009
If you've become overwhelmed with credit card debt, you have no doubt received countless pieces of mail from a plethora of different consolidation service firms offering their credit card debt repayment services to you. Whether they call themselves credit counseling services, debt repayment plans, consolidation loan firms, or loan modification companies, they all do essentially one of two things: they either work with your credit card companies to reduce the amount you owe (or at least the monthly payments), or they consolidate various high-interest loans into a single payment (at a still high, but hopefully less so, interest rate). There can be value in both approaches, so lets explore the pitfalls to watch out for in both instances.
First, before you obtain any professional services to lower your credit card payments or balances, make sure you exhaust all possible options yourself, personally. The rationale is simple: any time you obtain a service from a credit consolidation firm, you are paying them, whether you realize it or not. Credit card companies are willing to compensate these agencies if they think it will help them collect something from you, but in almost every instance, these are just savings going to the consolidation company, instead of into your pocket. If you can do the same work yourself, you may be able to realize more savings on your credit card debts. So, give your creditor a call and see if they will work with you. Simply asking for a reduction in your interest rate, or a reversal of fees, can very often result in money saved. Credit card companies have even been known to stop charging you penalties for an entire year, just for asking. It never hurts to ask, so always remember: credit card companies would rather have you re-pay what you owe than have to sell your debt off to a collection agency. They want to be reasonable, so give them the opportunity to work with you.
If, after exhausting all your options with the credit card companies yourself, you are still unable to get on top of your debt, you may want to work directly with a credit counseling agency. They have the advantage of working in the credit card consolidation field every day, all year long, so they may have more proficiency than you could ever expect to have, or know some tips and tricks to work with specific companies. They might even have some personal connections that can make things happen, which is always a benefit of an established firm or agency working on your behalf. Sometimes, you might hit a brick wall talking to the credit card company yourself, and then a debt management firm will come in and instantly reduce your payment significantly. This is where the value of these firms comes into play, and theres nothing wrong with taking advantage of them. Just remember that they are, somehow, being compensated for their work -- so use them as a last resort, but do take advantage of them when all else fails. They can certainly save you money, and saving some money (while their agency gets paid) is certainly superior to not saving any money at all.
Finally, you may want to take advantage of a debt consolidation loan. There are two types of loans: secured and unsecured. A secured loan can be taken against your house, your car, or any other significant asset you have. Companies are willing to extend a lower interest rate to you on a secured loan, because if you do default, they have a claim to your property. This mitigates their risk, and they are thus able to offer lower terms to you. Obviously this is the preferred method, as long as you are confident in your ability to repay the loan. It could be the difference between a 12% secured loan, and a 24% unsecured loan. Another option is to talk directly to your bank: they do offer personal loans at fairly reasonable rates (certainly less than you're paying on your credit card), but usually they are only for a few thousand dollars, at the most. This might help you out, but if you're very heavily into debt, it probably won't be an ideal solution for you. But again, this is something you can do on your own, so check with the bank first, before engaging a debt consolidation firm and asking for help.
No matter what direction you decide to take, its important to recognize the reason that you are in debt in the first place. If you are a habitual shopper, using your credit cards to live above your means, simply consolidating all your debts won't help the underlying cause. You need to address the habits that have placed you in the situation you are in today, and focus on improving yourself. Otherwise, you will fall back into your old ways, and continue to slip further and further into debt. The most important decision you can make is to take personal responsibility for your situation, and work towards a solution that will get you back on track. Whether you decide to employ a credit counseling agency, or take advantage of a debt consolidation loan to eliminate your credit cards, or simply work directly with the companies yourself to eliminate your high interest debts, you need to sincerely remain diligent and focused on your goal to get out of debt.
As a final word, when working with creditors or debt consolidation agencies, keep in mind that they do want to help you. No matter how frustrated you get, taking out your anger on the person at the other end of the phone will never improve your situation, and could likely ensure that they don't go out of their way to help you. Be curteous and professional, but firmly work towards a solution that will help both you and the credit card company. Remember, both sides want to reach an equitable resolution -- you need something fair and manageable that works for you, and they want to get their money. Certainly, some common ground exists between both parties, and remaining level-headed will ensure that you receive the best terms available.
Getting out of debt is going to be hard work, no matter how you look at it, but by using these techniques, you can ensure that you get there as quickly as possible. Debt consolidation firms may provide additional resources for you, but always try working directly with your creditors first; you might be surprised just how interested your credit card companies may be to work with you towards a payment plan that ensures they (eventually) get what they're owed.
- Posted by NateKragness on October 13, 2009
Almost everybody has at least some debt, and there are many reasons you might find yourself owing money to others. Unfortunately, most financial pundits don't appreciate that there are plenty of valid reasons to go into debt, and not everybody is just living above their means and squandering their income. For example, most people I have worked with have debts related to investments, whether its investing in their own education (student loans), real estate (rental property mortgages), small business loans (or credit card debts related to the business), etc. Medical bills and funeral expenses are also fairly common. But, regardless of how you managed to get yourself into debt, if you want to live a debt-free life, the escape plan is always the same. However, there is a lot of contradictory advice out there regarding the best way to get out of debt, and in this article we will compare and contrast the two prevailing methods.
Before getting into the specifics, there are some action steps you need to take, regardless of which method you decide to employ to escape your debts. First, you need to have a clear understanding of where you stand. Make a list of all your debts; include the name of the creditor, your account number, the current balance, the minimum payment required, and the interest rate on the debt. Once you have aggregated this information into one location, you will have a clear view of where you stand, and where you need to go. Next, decide which debts, if any, you don't need to pay off. Sometimes, carrying a debt is a good thing. For example, if you own a rental property that has positive cashflow, there's not really a pressing need to get rid of that mortgage debt. If your renter is paying the mortgage interest, that investment is making money, in spite of the debt. There's no pressing need to pay that off, and it shouldn't be a high priority. Additionally, if you have very low-interest loans, you might not want to pay those off either (Does Paying Extra on your Mortgage Make Sense?). Keep in mind that debt is not inherently bad, and you shouldn't indiscriminately try to eliminate all debt from your life (at least initially). Part of making prudent financial decisions is recognizing and differentiating good debts from bad.
Now that you have your aggregated list of debts in hand, we can consider the two prevailing methods of debt reduction. The first, popularized by Dave Ramsey, is called the "debt snowball" method, and it focuses on paying down your lowest balance first, regardless of the interest rate. So, if you have a $500 credit card balance and a $4,000 student loan, you would focus on the credit card first, and once it is paid off, move on to the student loan. Employing this methodology, you will see your smallest debts being eliminated first, and the theory is that this will provide emotional motivation for you to continue eliminating the rest of your debts. I call it the instant-gratification method, as you see tangible results quicker, but it ultimately takes longer to get out of debt. And how gratifying is it, ultimately, to pay more interest than you need to?
If you're serious about getting out of debt, it only makes sense to do it in the most prudent manner possible, and this brings us to the second method, which is to focus on the debts with the highest interest rate first, regardless of the balance on the account. This means you will ultimately pay less interest over time, and you also pay off all your debts faster. It's true that, using this method, you don't have the gratification of seeing your individual accounts being paid off, but you DO see your total debt decreasing even faster than with the "debt snowball" plan. To keep yourself encouraged, and provide a similar level of emotional gratification to the Dave Ramsey strategy, make a chart or spreadsheet that tracks ALL your debts, and see how quickly you're eliminating them as a whole, as you focus on the highest interest rates first. Eliminating low-interest debts while you are being destroyed by high-interest balances is financially irresponsible, and using the excuse that its "emotionally motivating" to be imprudent is just a cop-out. You need to eliminate your debt as quickly as possible, and you do this by paying down the highest interest rates first. It's simple mathematics, and that should be all the motivation you need.
To better understand these two plans for debt-reduction, consider the following (intentionally exaggerated and extreme, but still valid) hypothetical example: suppose you have a $10,000 student loan at 4% interest (minimum payment $200), and a $20,000 credit card balance at 29% interest ($500 minimum payment). Now, suppose you have an extra $300 per month to apply towards debt reduction. According to Dave Ramsey, you should focus all your efforts on the student loan, while making minimum payments on the credit card. With the extra $300 per month towards the student loan, it would take about 17 months to completely eliminate that debt, leaving you with just the high interest credit card. You would now re-direct the funds you were paying towards the student loan into the credit card, meaning you would be paying $1,000 per month on it. It would take another 30 months to eliminate the credit card, and so the total time using the "debt snowball" plan would be approximately 3 years and 11 months. You would have paid about $16,000 in interest using this method.
Now, consider the scenario if you instead focus on eliminating the high-interest credit card first. Since you would be paying $800 per month towards it, it would take about 33 months to eliminate the credit card debt. Re-directing those funds into the student loan would eliminate that balance in another 6 months, meaning you would be debt-free in about 3 years and 5 months. You would have paid about $10,000 in interest.
As we can see, using the instant-gratification "debt snowball" method costs more than $6,000 in extra interest payments in our example. Clearly, paying down the debt with the highest interest rate makes the most prudent financial sense. And for me, personally, I find a whole lot more gratification in saving $6,000 than in seeing one of my debt balances reduced to zero. When you think about it, does a completely arbitrary number (the number of accounts you own with a balance) really matter? If you owe $30,000 on one credit card, how is that any different than owing $30,000 split between ten cards? The number of accounts you have is completely meaningless, and for that reason the "debt snowball" plan really doesn't make sense. If paying your low-balance debts gives you emotional gratification and encouragement, and helps you to eliminate your debts, great. I suppose its better to get out of debt than to not, even if you do choose to pay a lot of extra interest in the process. But, I really don't see how you would be emotionally pleased to realize you're paying an extra $6,000 for absolutely no reason. Make a commitment to eliminate your debts, focus on the highest interest rate, and track your progress. You'll save a ton more money than the "debt snowball" plan, and that fact alone should be all the motivation you need to get yourself out of debt.