The secret behind debt consolidation.

     The secret to debt consolidation is to first eliminate the debt with the smallest amount or the debt with the highest interest rate. Afterwards, continue paying the same amount of money from the debt(s) already paid towards the larger or higher interest rate debt(s) until all the debts are paid in full which is a technique called debt stacking. The amount of time to pay off the debt(s) will be greatly reduced. Many companies advertise debt consolidation programs requiring a fee to use their services. Instead, you can learn the techniques yourself, achieving the same results at no extra cost.

     The following is an example and a solution to a debt obligation that is not uncommon for many individuals in this country:

type of debt	amount    interest	payment	years until 
		owed				paid
==========	======	    ====	====	=====
credit card #1	$ 2,000	     18%	$ 98	 2.0
credit card #2	$ 1,500	     15%	$ 93	 1.5
student loan	$10,000       9%	$126	10.0
car loan	$ 8,000       8%	$218	 3.5
mortgage	$60,000	      8%	$463	25.0
     The above illustration indicates all debts will be paid after 25 years (assuming no additional debt obligations). The following descriptions will show how the same debts will be paid in about 10 years.

     After 1 year and 6 months, the $1,500 balance from credit card #2 will be paid. The remaining debts will then be:

	credit card #1	$  600	car loan	$ 4,870
	student loan	$9,026	mortgage	$58,856
     Continue applying the payment for credit card #2, but now towards credit card #1, thus paying $191 instead of $98. After 4 months (instead of 6 months if the payment was not increased) credit card #1 will be paid. After a total of 1 year and 10 months, the remaining debts will be:
	student loan	$  8,792	mortgage	$58,583
	car loan	$  4,122
     Continue applying the payments for credit card #1 and #2 to the car loan, thus paying $409 instead of $218. After 11 months (instead of another 20 months if the payment was not increased) the car loan will be paid. After a total of 2 years and 9 months, the remaining debts will be:
	student loan	$  8,109	mortgage	$57,793
     Continue applying the payments for credit card #1 and #2, and the car loan to the student loan, thus paying $535 instead of $126. After 17 months (instead of another 7 years and 3 months) the student loan will be paid.

     Thus, all the non-mortgage debts will be paid after a total of 4 years and 2 months, instead of 10 years. Now concentrate all the payments of the past debts towards the mortgage. The mortgage will then be paid in 5 years and 11 months (instead of another 20 years and 10 months).

     In conclusion, by continually consolidating the debts paid towards the next debt, all the balances were paid in 10 years and 1 month instead of 25 years. The secret is to continue the payment obligation you are already accustomed to towards other debts. The process takes discipline, but the results are very rewarding.

     Another option, transfer the credit card balances to low interest cards offering 6% (see the credit card illustration earlier this book) and continue making the same payments. The credit cards will be paid in 1 year and 7 months. The car will be paid in a total of 2 years and 7 months. The student loan will be paid in a total of 4 years 1 month. Finally, the mortgage will be paid in a total of 5 years and 10 months.

     The above debt consolidation description is essentially the same principle followed by many debt consolidation companies, except the process will take a few months longer. The reason for the extra time is because you are paying the company a fee to manage your debt. You would make one payment to the company for them to distribute to all your debts. The company may instead establish a new consolidated loan to pay the other debts. You would then be making one loan payment for the consolidated loan. A consolidated loan allows you the opportunity to pay less per month, but the length of time until the debt is eliminated will then be increased. The fees charged will either be an additional charge per month added to the monthly payment or the fee will be included in the monthly payment.

     Homeowners receive many advertisements offering to consolidate their debt and save money. Examples of the payments before and after a debt consolidation are portrayed in the advertisement, but no indications of the interest rate or details about the debt consolidation are revealed. The solution advertised provides you with a second mortgage using the equity in your home as collateral or to provide you a second mortgage for an amount greater than the equity in your home. The interest rate for the loan that is greater than the equity in your home will be higher than a loan based on the equity in your home. The reason is because the mortgage company is assuming a greater risk by loaning you money without collateral. Using the example described earlier in this section, a second mortgage would not be able to consolidate all the debt because the home has only $3,100 in equity after 5 years. Although, a second mortgage would be helpful if the home contained $21,500 in equity. The resulting second mortgage of $21,500 with an 8% interest rate and a monthly payment of $535 (the same amount as the payment for the credit card, student loan, and the car payment) would be paid off in 3 years and 11 months. Also, the interest from the second mortgage can be deducted on your yearly IRS income tax return. You can then apply the same payment towards your mortgage to pay the loan faster or you can use the money to buildup your savings.

     In any case, you can achieve the same results on your own faster and cheaper with discipline and good money management techniques. If you are not able to discipline yourself, then a debt consolidation company is the answer for you. The company will force you to become disciplined and provide the means to eliminate your debt. In any case, you will become debt free with funds freed up to apply towards retirement.


Return to Debt Management Topics.