July 25, 2018 – By Mark Henricks
After she left her corporate job to start a coaching business, Christy Whitman rang up $90,000 in credit card debt. “Paying it off seemed impossible, given that I was only making $60,000 a year as a brand new coach,” said Whitman. To make the task more manageable, she took out a consolidation loan.
“The moment I consolidated all of my credit card debt into one monthly payment, I could see the light at the end of the tunnel,” said Whitman. With that, her enthusiasm for her new venture reignited and she was able to pay off the full $90,000 in a little over two years. Later, Whitman, who lives in Scottsdale, Arizona, became a widely known transformational leader and bestselling author of “The Art of Having It All.”
The Power of Personal Loans for Debt Consolidation
Many consumers have made similar transformations of their financial lives through personal loans. These let them consolidate high-interest credit card debt into a single term loan with fixed payments and lower interest rate.
The way personal loans are designed offers consumers one particularly nice advantage, namely, the ability to bring into focus that light at the end of the tunnel when they will be debt-free, said Katie Ross, manager of education and development and housing for American Consumer Credit Counseling, a non-profit member of the National Foundation for Credit Counseling in Newton, Massachusetts.
“Having one large loan payment as opposed to multiple credit card payments will make your finances more manageable,” Ross said. “The fixed interest rate will also reduce the duration you spend paying your debt.”
A lower interest rate also means more of each payment will be going toward principal, added Scott Stratton, a certified financial planner with Good Life Wealth Management in Dallas. “The more going toward principal and the less toward interest, the faster you’ll be able to pay off credit card balances,” he said.
A Debt Payoff Plan
Perhaps the biggest advantage of consolidating credit card debts into a personal loan is the fact that there is a time limit. While the payment may be larger than the minimum balance on credit card accounts, borrowers know that if they pay it every month for a preset number of months, the balance will dwindle to zero. That’s a plan to look forward to.
“This establishes commitment and a process for getting rid of it,” Stratton said. “Whereas if you just send in a minimum each month, you’ll be paying for it forever.”
Minimum required monthly payments on credit cards may be as little as 1 percent or 2 percent of the balance, Stratton said. “When you’re paying 20 percent interest or more on that, you’re not even treading water,” he said.
Indeed, if a card has a $2,000 balance and an 18 percent annual rate, a borrower making a minimum payment of the larger of either 2 percent of the balance or $10 would be paying on it for more than 30 years, according to one online credit card payoff calculator. During that time, the borrower would pay more than $4,931 in interest on the original $2,000 debt.
Having a regular fixed payment also makes it easier to budget, Stratton said, since borrowers know exactly how much they will pay toward their loan every month.
While consolidation loans can be extraordinarily helpful to consumers carrying high loads of credit card debt, they can’t create good financial health by themselves. Consumers can help themselves further by reducing the chances of getting back in debt later on through acquiring good budgeting, spending and saving practices including creating an emergency fund.
“Folks who have excessive debt or the wrong kind of debt for the wrong reasons really need help in two arenas,” said Barry Korb, a certified financial planner with Lighthouse Financial Planning in Potomac, Maryland. “First how to get out of debt. And second and more importantly, how not to return to their old ways.”
Stratton added that borrowers should consider their future borrowing plans before taking on a consolidation loan. Having a loan with a fixed monthly may be a negative factor if, for instance, they apply for a home mortgage loan that limits the borrower’s debt-to-income ratio, he noted.
Summing Up Consolidation Loans
A consolidation loan doesn’t eliminate the risk of getting into debt with credit cards again. But in part because of the way it puts a time limit on debt a consolidation loan can be a useful part of an overall plan for managing debt and maintaining good personal financial health.