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My Research
Let's start with the basics.
What is Debt Consolidation?
Want to know a startling statistic? According to an article published in TIME, "73% of Americans die in debt, taking nearly $62,000 with them to the grave" (Calfas, 2017). #yikes So, it's no surprise that we as consumers look for help to eliminate or pay off debt fast.
If you have followed my blog, you know that my personal #moneyguru is Whitney Hansen at whitneyhansen.com; I worked with her one-on-one to create a strategy to help me pay off my debt because I felt like I was #drowning at only 24 years old. When we first started working together, I asked her if consolidation would be a viable option; her response was, "Let's see what kind of work you can do on your own and then we can talk about it." Truth is: I didn't even know what it was.
Anyone who is working on their financial life knows (or should know) Dave Ramsey; he is basically one of the best of the best. According to Dave, "Debt consolidation is the combination of several unsecured debts—payday loans, credit cards, medical bills—into one monthly bill with the illusion of a lower interest rate, lower monthly payment and simplified debt relief plan" (Ramsey, 2018). Basically, look at it like this:
Say you have ten freelance remote jobs out across the entire country: one in Sacramento, another in New York, two in Dallas, two in Chicago, three in Boise and one in Seattle. You have to report to each one at different times, the terms are unique to each job and you are required to meet certain deadlines. This may become difficult to keep track off. Not to mention you like to spend a few hours a week at your gym, volunteering at the Humane Society and don't forget going out with your friends.
If you were to apply debt consolidation to this situation, you would pitch the idea of bringing all of the projects together to be able to achieve the goal with (hopefully) fewer monthly meeting obligations... Alright, this analogy may be a stretch but hear me out.
You're pulling all of your responsibilities into one spot, usually with the promise of a lower interest rate.
The Pros
1. You are able to simplify your budget by crunching all of the payments (hopefully) into one.
If you did successfully consolidate these 10 freelance jobs, you could pull all of your resources together and work cohesively toward a goal.
2. You have the possibility of getting a lower interest rate than those currently on your debts.
Yeah, I have #literallynoidea how to relate this one to the freelance gig... Maybe it's fewer hours out of your week because you're working cohesively. Let's go with that.
3. Combining the payments could potentially lower your total monthly costs of your debt.
Let's say with the 10 separate freelance gigs, you are currently working 80 hours a week. By consolidating the work, you may cut it down to 50 or 40 hours a week.*
*Side note: I have consolidated my credit cards once. I transferred a couple balances from cards that had 16-19% interest to a 0% offer. We will come back to this.
The Cons
1. You may get the offer for a lower interest rate initially but then the lender can jack it up.
When I took the 0% offer, I was so stoked. I thought, "Wow. I have 15 months of interest free. This is great." I made my payments and all was good until that 16th month when my interest skyrocketed to a whopping 23%. Oh, and what the fine print tells you (and the agreement that the person on the phone reads you) is that if your debt isn't paid in the allowed time, you will pay interest on the original transferred amount. #oops
2. It's still the same amount of debt.
This doesn't improve your debt-to-income ratio or, like, magically turn everything around. You're still in debt and still need to pay it off. It's just attractive because you don't have to risk missing payments because you potentially only have one and your interest rate is (typically temporarily) lower.
3. This doesn't fix the issue at the root: your spending habits.
My mom plays the 0% game like it's nobody's business. She will use her credit cards when necessary, make her payments and because her credit score is 800+, she will get these exclusive offers at least once a month. She figures out how long the offer is good for, how much she can transfer, and what the estimated monthly payment would be to pay off the total transferred in the allotted time.
I have also played this game; however, I missed that last part. Oh, I also looked at my $0 balances and was like, "Hey! I can go do X, Y, and Z because I don't owe anything on this credit card." #dumbmillennial
So, this tactic works for my mom to help her pay off her debt; however, this just enables me to continue to spend the way I do, make the minimum payments and screw my future self when I have plastic in my hand.
According to my man, Dave Ramsey, "Most of the time, after someone consolidates their debt, the debt grows back. Why? They don’t have a game plan to pay cash and spend less. In other words, they haven't established good money habits for staying out of debt and building wealth. Their behavior hasn’t changed, so it’s extremely likely they will go right back into debt."
My Thoughts
Ride like the wind, Bullseye.
Debt sucks. You should get out as fast as you can. Some people say they don't mind being in a little debt; I'm the opposite. It feels like the ball-and-chain holding my back from my dreams. In my opinion, you should find the best way for you to get out of debt and do it quickly.
From working with Whitney and doing my research online, I've learned of three different methods to paying off debt. Below there is a brief description and my opinion of when you should use each.
Debt Consolidation: Compiling all of your debt into one payment by taking out an extended loan with a potential lower interest rate.
When To Use It: If you are constantly paying late fees and can't seem to remember when to pay what, debt consolidation may be an option.
My Recommendations: First of all, write out a budget. Second of all, figure out all the details. What are your current interest rates? How long would the loan be? What would the monthly payment be? Would you be saving money?
The next thing I would recommend would be to use this as a tool; don't look at it as you have a lower monthly payment so you have more money to put elsewhere. Use the money you're saving, put it toward your monthly payment and pay the debt down faster. For example, let's say you have 5 debts that total $20,000, breaking down to $1,000 coming out of your monthly budget; if you were to consolidate, you would have a loan of 60 months, a lower interest rate of 2% and a monthly payment of $600. Most would look at that and celebrate a savings of $400 per month; however, if you calculate $600 for 60 months, that's $36,000 vs. the $20,000 you have now. If you were to continue to pay the $1,000 per month, you could have the debt paid off in under two years (if my math is right... don't quote me on this). But you get the idea.
If you were to take on this strategy, always pay more than your monthly payment and plan to pay it off well before the end of the terms. Also, get rid of your credit cards to eliminate the possibility of going further in debt.
Debt Snowball: Pay the minimum due on all debt but your smallest and pay that off first then apply the payment to the next smallest debt, etc.
When To Use It: If you're paying extra on all of your debts and feel like you're never making any progress.
My Recommendations: Debt. Snowball. Saved. My. Life. Okay, actually it was Whitney Hansen... but it's because she taught me about this strategy. So, when I first started working with Whitney, I had like 8 debts I was working to pay off. I was paying an extra $25-75 on each debt to try and pay them off quickly. Looking back now, I wish I could slap my old self.
Let's break this down. Let's go back to those 5 debts you have totaling $20,000:
$12,000 in student loans (minimum $200)
$4,000 for that car you bought (minimum $200)
$2,500 on a credit card (minimum $100)
$1,000 on another credit card (minimum $50)
$500 on a store credit card (minimum $50)
If you only made the minimum payments, you could be paying $600 per month. However, you have been paying $450 to knock out your student loans, $250 on your car loan, $100 on the first credit card but you pay $100 each for the other two credit cards, totaling your $1,000 per month.
If you keep paying these amounts, your debts could be paid off in:
Student loans ~ 27 months
Car loan ~ 9 months
First credit card ~ 25 months
Second credit card ~ 10 months
Store credit card ~5 months
Let's think about changing to the snowball effect. First, we would rank the debt from smallest to largest:
$500 (with $50 minimum payment)
$1,000 (with $50 minimum payment)
$2,500 (with $100 minimum payment)
$4,000 (with $200 minimum payment)
$12,000 (with $200 minimum payment)
Now, instead of applying to extra to all payments, we would apply the extra cash (originally paid $1,000 per month but the minimum due is $600 so we have an extra $400) directly to the smallest debt, in this case the $500. So, now our payments would look like this:
$500 (with $450 payment)
$1,000 (with $50 minimum payment)
$2,500 (with $100 minimum payment)
$4,000 (with $200 minimum payment)
$12,000 (with $200 minimum payment)
We could pay off the $500 store credit card debt in just over a month!
Let's keep going though. Let's say you pay off that card in two months. You've paid the minimums on everything else so your total has gone down; now, you can put the extra $450 toward the next smallest debt.
$500 (GONE)
$900 (with $50 minimum payment + $450 extra = $500)
$2,300 (with $100 minimum payment)
$3,600 (with $200 minimum payment)
$11,600 (with $200 minimum payment)
You can now pay your second debt off in another two months compared to the original 10 months! If you continued the snowball effect, you could be DEBT FREE in 21 months, six months faster than if you paid the extra on each debt!
If you are someone who needs to see progress quickly, then I would highly recommend this strategy. I remember the first card I paid off. I called Whitney and cried. It felt so great to know I could cross off of the debts!
Still would recommend getting rid of the plastic though. #cutthemup
Debt Avalanche: Pay the minimum due on all debt but the debt with the largest interest rate and pay that off first then apply the payment to the next largest, etc.
This is the same concept as the debt snowball but it targets the highest interest rate. You would find the debt with the largest interest rate, throw as much extra cash at it as you can and then push the minimum from that debt onto the next debt.
This method is good for those people who see their massive student loan debt and want it gone first. For me, I need to see those small wins; interest definitely sucks but I want to eliminate the number of debts I have rather than tackle the interest at this time.
This method can save you more money in the long run but can feel like it will take you forever to get out of debt.
Summary
Debt is awful. I think we all should aim to live #debtfree and cut up our credit cards; however, life happens and millennials tend to be dumb with money. #guilty I don't think there is a "quick fix" to get you out of water; it takes hard work, developing (and sticking to) a budget and finding a strategy that works best for you!
I hope that my explanation of these strategies can help you make a more educated decision toward your financial goals. And just a reminder: I'm no mathematician nor am I a money expert. There are probably flaws in my calculations but these are the general concepts and the findings I found to report to you, my readers.
Just remember: I still have #literallynoidea how to adult with my money, but we can learn together.
Cheers.
The Good Stuff:
http://whitneyhansen.com/snowball-effect-and-buying-stolen-credit-cards/
https://www.daveramsey.com/blog/debt-consolidation-truth
http://time.com/money/4709270/americans-die-in-debt/
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