How to Create a Debt Management Plan

How to Create a Debt Management Plan

For many people, debt has unfortunately become a way of life. The Center for Microeconomic Data’s Quarterly Report on Household Debt and Credit showed that total U.S. household debt in the third quarter of 2018 was the highest it’s been since 2008. Total household debt rose to $13.51 trillion, an increase of 1.6% from the previous quarter.

Given that the U.S. population is estimated to be 325 million, that’s enough debt for each U.S. resident to have $39,169.23 worth of debt to their name. Since not every person has debt, the reality is that some people have much higher balances than others. For instance, an increasing number of Americans carry their student loan debt for years before they can pay it off. This means many may have student loans, credit card debt, a car loan, and a mortgage all at once.

For those who are overburdened with debt, finding a way to get out of debt and reduce monthly debt payments could help them get their finances back on track.

Debt consolidation won’t lower the amount of your debt; however, it could reduce the total interest you’ll pay over time if you’re able to move high interest rate debt to a loan with a lower interest rate. In some cases, though, depending on the interest rate and loan term, consolidating may cause you to spend more out of pocket than if you had kept your loans separate. In either case, what’s appealing to people about debt consolidation is that it usually creates a single, lower monthly payment, spread out over a longer period of time, which can help make the debt easier to manage. It’s important to remember that while consolidation doesn’t eliminate debt, it’s a way to manage paying it off.

What is Debt Consolidation?

If you’re looking for a way to reduce or manage your debt, you may have considered debt consolidation. While it’s not the right option for everyone, debt consolidation can help some people lower their monthly payments and regain control of their finances.

Debt consolidation is the notion of merging multiple loans or debts into one single loan. Instead of making multiple payments to a number of creditors each month, you make a single payment to the company that owns the consolidation loan.

Get Control Over Your Debt

If you’re in debt, organize and add up the debts you owe and create a budget to understand how much money you can put toward your debt each month. It’s important that you prioritize paying off high-interest debt first, so you don’t pay any extra money unnecessarily.

Create a list of your monthly expenses and compare them alongside your monthly income. Your expenses should include essentials like rent or mortgage payments, bills, and food, as well as nonessentials that you can cut back on.

Once you’ve created a budget, you have to stick to it. This means making money-conscious decisions like avoiding impulse purchases and not adding any credit card debt.

However, depending on how much debt you have, you may need to increase the amount of money you put toward your debt payments every month. Debt consolidation may help make this easier.

Four Ways to Consolidate

  • Use Balance Transfer to Lower Credit Card Interest Rates: If you have credit card debt and would like to condense payments into one credit card or possibly lower your interest rate, consider doing a balance transfer to another credit card. For those who qualify, PSECU offers a no fee balance transfer rate to encourage consumers to move their debt. However, you’ll want to make sure the money you’re saving during any introductory period isn’t outweighed by fees and the standard interest rate after the balance transfer rate expires.
  • Have Student Loans? Learn About the Federal Consolidation Program: Debt consolidation can take several forms. For example, student loan consolidation is available for eligible borrowers with federal student loans. The federal consolidation program allows you to make one monthly payment and lock in a fixed interest rate, instead of a variable rate. The interest on a federal consolidation loan is often lower than on other student loans, depending on when the original loan was disbursed. If you’re interested in pursuing this path, make sure to check the federal program rules.
  • Own a Home? A Home Equity Line of Credit Could Possibly Lower Your Interest Rate: Some people consolidate debt by taking out a home equity loan, also known as a second mortgage. A home equity loan allows you to borrow against a percentage of the equity you have in your home. The amount you may borrow depends on your equity and the home’s market value. A home equity loan can be used to pay off consumer debt such as credit cards and car loans, which tend to have higher interest rates than a mortgage. Like consolidating student loans, consolidating consumer debt with a home equity loan allows you to pay off existing loans and make a single monthly payment. Of course, it’s important to make sure you can manage loans on a second mortgage, as you’re using your home as collateral.
  • Use a Personal Loan to Condense Multiple Loans: If you don’t own a home or don’t have enough equity built up in your home to borrow against it, you have a few other avenues for consolidating consumer debt. One option is to apply for a personal loan and put the amount of the loan toward paying your current debt. Depending on your credit history and score, you may be able to consolidate your debt on your own by applying for and receiving a new loan. However, if you’re deep in debt, you may also be dealing with a low credit score or a credit history that makes lenders think twice about issuing you a loan.

6 Reasons Borrowers Consolidate

Since debt or credit consolidation isn’t for everyone, how do you know if it’s the right option for you? Below are a few reasons borrowers may consider themselves to be good candidates for consolidation.

  1. They’re ready and prepared to get out of debt. Consolidating loans into a single loan can be the first step toward finally saying goodbye to debt. But consolidation is just a tool for reducing debt — it’s not a magic solution. To take advantage of consolidating loans, borrowers need to be prepared to prioritize paying down debt and committed to avoiding future debt. This means not using the credit cards that were recently paid off with a balance transfer or consolidation loan to make new purchases that can’t be paid off in full. It also means being willing to pay more than the minimum amount due on the consolidated loan each month.
  2. They’re paying sky-high interest rates. Consolidating loans might be a good option for borrowers struggling with high interest rates. If they’re currently paying 15-20% interest on one or more credit cards and have the option to transfer those balances to a card with a significantly lower interest rate, doing so can reduce monthly payments and save money.
  3. They want a fixed interest rate. Variable interest rates may seem great, at first. But once the promotional period or “teaser rate” ends, the rate often jumps. Borrowers tired of paying variable interest roulette who’d like a rate they can depend on might consider consolidating their loans into a single loan with a fixed interest rate.
  4. They’re OK with trading a longer payment period for lower monthly payments. One of the drawbacks of debt consolidation is that depending on the interest rate and loan terms, borrowers may end up paying more over time. But if they need lower monthly payments now, the idea of paying more in the long run may be acceptable. They might find they’re able to bump up the amount they pay in the future, speeding up the payment process.
  5. They’re tired of juggling multiple monthly payments. If borrowers regularly forget to pay bills or struggle to keep track of payments, consolidating can help them get organized and streamline debt.
  6. They regularly miss payments or pay late. If having a variety of due dates or multiple bills due each month leads to occasionally missing payments or making late payments, consolidation may help. Borrowers will still need to remember to pay their bill, but it may be much easier to do so with one.

When Debt Consolidation May Not Be Worth It

Although debt consolidation can be the right option for a number of people, for others, it may not be worth it. Below are a few signs that suggest debt consolidation may not be worth a borrowers’ time.

  1. You’re not ready to face your debt. Some treatments focus on easing the symptoms of an ailment, but don’t actually provide a cure. That can be the case with debt consolidation. If you’re not yet committed to avoiding future debt, using a consolidation loan to pay off your current obligations will help you in the short-term, but it won’t lead to lasting changes in the long run. In some cases, people consolidate their loans only to find themselves deep in debt once again a few years later. Until you change your perspective on, and approach to, borrowing money, debt consolidation will only be a temporary fix.
  2. Your debt is almost entirely paid off. If you’re nearing the end of payments on your loans, consolidating your debts may simplify your life slightly, but the process of taking out a new loan and paying off your current ones may be more trouble than it’s worth.
  3. The interest rate isn’t so great. Consolidating your debt doesn’t always lead to a significantly lower interest rate. For example, under the Federal Student Loan Consolidation program, the interest rate you end up with is the weighted average of the interest rates on your current loans. If your loans have similar rates, consolidating them may not lead to a considerably lower monthly payment. Also, depending on your credit, you may not be able to get the lowest interest rate possible on a personal loan or credit card balance transfer.
  4. The fees are high. If you work with a debt consolidation company, you can expect to pay fees, and in some cases, those fees can outweigh any benefits of consolidating your debt.
  5. Your minimum payment may be higher each month. Depending on the terms and rate of the consolidation loan, you may end up spending more each month on debt payment. That’s not necessarily a bad thing if it means you’ll be out of debt sooner. But in some cases, it may be easier to simply pay more toward your current individual debts each month.

Risks of Debt Consolidation

Before you make any decisions about what to do with your money, it’s essential to understand what risks are involved and what the extent of those risks may be. Debt consolidation isn’t the perfect solution, and it may cause a few issues if you aren’t careful. The risks you might face depend significantly on the type of debt consolidation loan you decide to use.

  • You could put your collateral at risk. Although a home equity loan can be a way to consolidate debt, it does introduce one significant risk to the equation. If you trade unsecured debts, such as credit cards or medical bills, for a second mortgage or home equity loan and aren’t able to pay, the creditor can come after your home, which is collateral on the loan.
  • You could end up with more debt. If you haven’t sat down and made a budget or come up with a plan to avoid additional debt in the future, a consolidation loan, especially a balance transfer card, can be a gateway to additional debt. If you haven’t fully committed to becoming debt-free, you may be tempted to use a loan or credit card to make additional purchases you can’t afford because you’re working on paying down the existing debt. If you do open a new credit card to help pay off your debt, it’s best to lock it away so that you aren’t tempted to use it for new purchases.
  • You could end up working with a dishonest company. Whether on the radio, on a roadside billboard, or in a newspaper, you’ve probably seen a company advertising its debt consolidation services or promising to help you get out of debt. While these companies may offer something similar to a debt consolidation loan, you’ll want to pay careful attention to the details of the program or service and do your homework. Although reading reviews, checking credentials and getting references can help you avoid scams, they are relatively common in the debt relief industry. If you’re not careful, you may end up working with a company that charges you extra fees, doesn’t actually deliver your payments to your creditors, or doesn’t have your best interest in mind. Get as much information about the company as possible and make an informed decision before you agree to work with it.

How Does Debt Consolidation Affect Your Credit?

Debt consolidation will have some effect on your credit score, but do debt consolidation loans hurt your credit? The type of effect it has depends on the type of program you choose to use. If you decide to apply for one of PSECU’s debt consolidation loans, such as a personal loan or home equity loan, we’ll pull your credit report and make what is called a “hard inquiry.”

The hard inquiry and the presence of a new loan on your credit history will likely cause your score to drop a bit. Usually, the drop is temporary, and since you’re working on paying off your loans, it could be worth it in the long run. By the time you’re finished paying off the consolidation loan, your credit score should hopefully level out.

If you are considering working with a professional credit counseling service or program, you should discuss how the program may impact your credit score, along with their terms of use so you understand what restrictions and benefits will be offered.

Is Consolidating Debt Worth It?

Depending on your circumstances, debt consolidation may be worthwhile. You may want to consider it if you’re ready to avoid future debt, create a budget to get your spending under control, and understand the pros and cons of your options. A debt consolidation loan can also help simplify your monthly payments. Depending on the interest rate, you may end up saving money, too.

Looking for more money management tips? Check out our WalletWorks page for more resources, videos, and financial tips.

The content provided in this publication is for informational purposes only. Nothing stated is to be construed as financial or legal advice. Some products not offered by PSECU. PSECU does not endorse any third parties, including, but not limited to, referenced individuals, companies, organizations, products, blogs, or websites. PSECU does not warrant any advice provided by third parties. PSECU does not guarantee the accuracy or completeness of the information provided by third parties. PSECU recommends that you seek the advice of a qualified financial, tax, legal, or other professional if you have questions.