Tom asks: “I was thinking about getting a debt consolidation loan. What do you think?”
Question 3 – Is Debt Consolidation Right For Me? – Shownotes
Today’s question comes from Tom:
I have found myself in a good amount of credit card debt (£10,000) with high interest rates on some cards up to 27.99% APR. I am working hard to get rid of my personal debt and was thinking about doing a debt consolidation loan. What do you think?
First of all, good work . Getting yourself into £10k of credit card debt obviously wasn’t the smartest choice, but you are now tackling it and I can see two things that you’ve already done:
- I am working hard to get rid of this personal debt – you understand that it is a problem and you are tackling it
- You are asking the right questions and thinking about ways of getting rid of that debt as quickly as possible.
So, you ask about debt consolidation. A quick definition for anyone who isn’t aware, but the idea of debt consolidation is the act of taking multiple debts and placing them into one debt.
There are only two key factors to successful debt consolidation:
- Getting the lowest interest rate possible on the one consolidated loan
- Paying off the loan
Too often, you’ll see people consolidate several credit cards into one consolidated loan. The interest rate and the monthly payments become lower on the new card and quickly they slip back into their old ways and start racking up the credit card debt again or increase their spending because their payments are less.
DON’T LET THIS HAPPEN TO YOU TOM!
The first step is to determine if you can obtain a new card – many companies and websites now offer free “eligibility checkers” to determine if you might be accepted for a new loan.
Depending on your credit history, for £10k, you’ll have a few options, in reverse order of preference:
- Debt consolidation program: some providers offer a service whereby they will provide you with a loan, repay your old debts and set up a repayment plan going forward. However, these often incur a fee and the interest rates tend to be higher than what you could find if you look yourself.
- Unsecured personal loan: many providers offer loans of around £10k for under 4.0% APR. Under this arrangement, the lender will give you cash in exchange for repayments over an agreed time period. You can use the cash to pay down the credit cards, and then repay the loan as per the repayment schedule. For example, TSB currently offer personal loans at 3.9% APR at the time of recording.
- And my personal favourite in your situation: a balance transfer credit card: 36 month @ 2.39% fee. You can think of that as being 0.8% APR. Less than 1% interest a year.
With the balance transfer card, you can shift your £10k of existing credit card debt to this card for a fee of 2.39% (which equates to £239 up front). Then, if you can pay off £284.42 per month for 3 years, you’ll be debt free before the end of the term and you’ll never pay a penny more of interest.
If you left your debt as it was on 24.99% credit cards and made the same £284.42 payment per month, you would still have credit card debt of £5085 (incurring interest of £5,324 in that period).
If you carried on paying £284.42 each month until the balance was fully paid off, it would take 58 month (almost 5 years in total) and end up costing you almost £6500 in interest.
Therefore, by paying the upfront fee to consolidate all of your debt onto a 0% balance transfer credit card, you’ve saved over £5k and got rid of that pesky credit card debt for good.
Is debt consolidation right for you Tom? As long as you set a plan to repay the debt, and you get the best interest rate possible, it’s certainly more financially savvy than continuing to service those high interest credit cards.
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