Avoid these 4 Debt Consolidation Mistakes
Debt consolidation is often a sensible technique for digging out from under a debt pile. The strategy involves rolling high-interest debts into one debt that has a lower interest rate. Because of the lower rate, monthly payments should be lower, which allows the debtor to get out of debt quicker.
One common type of debt consolidation is the credit card balance transfer. If a debtor has three debts with interest rates of 17%, 15%, and 22%, she can roll them all onto one card, preferably at a very low interest rate, possibly 0%. Depending on how much the debtor owes, she could save hundreds a month on interest, which allows her to chip away at the principal much faster.
But not all debt consolidation strategies make sense. Below, our bankruptcy attorney highlights 4 mistakes to avoid.
Mistake #1: Don’t Use a Home Equity Line of Credit (HELOC) to Consolidate Debt
Using a HELOC might sound like a good idea, especially if interest rates are low. However, if you default on your loan, your creditor has a security interest in the property. This means they can foreclose on you and force a sale of your home.
Of course, some people are confident in their employment situation and don’t anticipate any financial difficulty arising that would make it hard for them to pay off their HELOC. Anything can happen, however. And if you are in such a strong financial position, you should consider getting a balance transfer credit card instead.
Mistake #2: Don’t Rack Up Charges on a Balance Transfer Credit Card
If you chose to transfer some debts using a balance transfer, you need to pay off the entire balance before you start making charges on the card. There is a simple reason—interest.
Let’s say you transferred $5,000 to a card that had 0% APR for 18 months. However, you started making additional charges on the card. The regular interest rate will apply to them. Furthermore, the credit card company can allocate your payments to the debt with the lower interest rate, which means interest will be accruing on the new purchases.
Mistake #3: Don’t Start Spending More
The entire purpose of consolidating debt is to lower your monthly payments, which allows you to contribute more money each month to debt repayment. Let’s say you have $600 in monthly credit card payments. If your balance transfer lowers it to $400, you have an extra $200 a month. Should you treat yourself to a shopping spree?
No! That money needs to go toward principal on your debt. If you spend it, then you are not getting ahead.
Mistake #4: Avoid Stretching Out the Repayment Period
One way to get a lower monthly payment is to stretch out the term of the loan. However, you will ultimately pay more in interest. For example, you might have a personal loan with a 2-year repayment period that costs you $150 a month. You shouldn’t consolidate with a loan that has a 5-year repayment, because you will end up paying much more, even if your monthly payments drop to $80 a month.
Would You Like to Discuss Bankruptcy with a Plantation Attorney?
Sometimes, loan consolidation is not enough to help our clients, who must file for bankruptcy to have any chance of regaining their financial footing. Please call our Plantation bankruptcy attorneys at Nowack & Olson today at 888-813-4737. You can schedule a free consultation.