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Tips from the debt doctor
By Andrew Willink
6 August 2008
Easing existing credit woes by taking on additional debt is not the quick fix it may appear to be. Simply getting a new credit card to pay off the old ones will give you symptomatic credit relief but not a credit cure. After all, the goal of consolidating your debts is to roll higher-interest balances into one, easier-to-handle and less-costly package.
This fighting-fire-with-fire approach takes several forms. The problem with debt consolidation is that it feeds on the tendencies that got you into trouble in the first place. By taking on yet another credit card or personal loan, you're adding the proverbial fuel to the fire. In this case, it's your money that's burning. Plus, if you've taken on so much debt that you're looking for more as a solution, chances are you won't qualify for the very low interest rates you see advertised. Those generally go to people with excellent credit ratings.
However, if you're at the end of your credit rope or swear that this time you'll be more disciplined, debt consolidation may be something to consider.
Here are some of the more popular forms of debt consolidation, how they work and what to look out for.
- Debt-consolidating personal loan
The major appeal of a personal loan to consolidate outstanding debts is simply convenience. Instead of paying off many different creditors who are charging different rates at different times of the month, you take out one loan to pay off all those accounts. You then make a single payment on that loan once a month. This method also works well for the financially undisciplined who have a track record of maxed-out credit cards. And, treat a finance product like every other product by shopping around for the best personal loan. It could be your favourite bank but it’s more likely to be a credit union or building society which specialises in this area.
- Zero-percent credit card
Balance-transfer offers of zero or a low-percentage interest rate are an attractive credit card option for those who are serious about reducing debt. It must also be remembered that these low rate credit card offers are enticements for you to switch to a new lender from other credit card providers. Think carefully about the offer. Will you realistically be able to pay off your debt within the promotional time frame? What interest rate does the card revert to when the promotional offer finishes? If you can’t pay off your balance before the higher rate kicks in, maybe you’re better off with a card offering a very small interest rate over a much longer period of time. The main trap people fall into with balance-transfer offers is that they actually start using the card. This negates any benefit the card ever had, as a zero or low-percentage balance transfer card only works if you are meticulous about paying it off in full before you are tempted to use it.
- Home equity loan or line of credit
Home equity loans are most commonly taken as a line of credit against your home. They are a quick and easy way to get out of debt by borrowing against your house and paying off other outstanding bills at the lower mortgage interest rate. Paying off creditors in this way can work for debt-burdened home owners but care should be exercised with this option. It is far too easy to create a never-ending debt by over-use of a line of credit so this option should be used sparingly.
Managing and not adding to, your debt is the aim. Equally, it is a pointless exercise simply shifting debt from one provider to another. Taking stock of exactly what you owe is the first step to working out the best way to pay off those bills. There are some excellent products out there if you shop around. Used properly, they are great tools for eliminating monies owed and putting you back firmly in control of your finances.
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