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 loan to consolidate her debt.
“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 loans let them consolidate high-interest credit card debt into a one set regular monthly payment with a fixed interest rate and repayment term.
“Having one large loan payment as opposed to multiple credit card payments will make your finances more manageable,” said Katie Ross, manager of education and development and housing for American Consumer Credit Counseling, a nonprofit member of the National Foundation for Credit Counseling in Newton, Massachusetts. “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 something 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 for years.”
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.”
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.
The limits of debt consolidation
While consolidating higher-interest debt into a personal loan can be extraordinarily helpful to consumers carrying high loads of credit card debt, they can’t create good financial health by themselves. Consumers must find strategies to reduce the chances of getting back in debt later. Good budgeting, spending and saving practices including creating an emergency fund can go a long way to supporting financial goals.
“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. 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 any loan. Having a loan with a fixed monthly payment 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.
The bottom line
A loan for debt consolidation 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 personal loan can be a useful part of an overall plan for managing debt and maintaining good personal financial health.
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