Do It Yourself Debt Consolidation

By Pinyo, on January 18, 2009

Debt consolidation companies often give you a fantastic pitch that promises to help you lower your monthly payments and eliminate debt.  All you have to do is work with them, combine all your debt obligations into one low monthly payment, and save tons of money.  Is it really that fantastic, or just a fantasy?

Personally, I have heard both sides.  On one hand, I have heard of good stories where individuals successfully worked with one of these companies and got their debt problem under control.  On the other hand, I have heard of horror stories where individuals placed their trust in these companies, made a couple of payments, and later got late notices from their creditors. The debt consolidation company was a fraud and they got into more trouble because of it. So the question is not only: should you pay a debt consolidation company?, but also how can you find the right company?

In this article, I am going to outline some steps where you can consolidate debt and get this problem under control on your own.

Change Your Attitude About Money

Before you even try to figure out how to get rid of your debt, you have to get rid of the habits and lifestyle that got you into this mess in the first place.  If you habitually spend more than you can afford, you need to fix this first.  Learn to manage your expenses and live within your financial means.  Otherwise, all your effort will be for naught and you’ll end up even worse.

How To Consolidate Your Debt

Now that you have your spending habits under control, it’s time to start working on your debt.

1. Make a list

Make a list of your debt with the creditor’s name, amount owes, interest rate, and type (i.e., secured loan versus unsecured loan).  Since your secured loans are collateralized, you could lose your home, car, or other valuables if you default on these loans. Therefore, these are the most important loans to keep your eyes on.  Whatever you ended up doing, your plan must be able to support the monthly payment of these loans.

Next, focus on debt obligations with the highest interest rates.  These are usually your credit card balances.  You want to get rid of your high interest loans as quickly as possible to save money on interest expenses.

In short, you should have a list grouped by secured versus unsecured status, and sorted by the interest rate.

2. Negotiate with your lenders

Many people often overlooked the option of negotiating with credit card companies and other lenders as a way to lower your interest rates and payments. Now call each of your lenders and ask them for a lower interest rate or a different payment term.  Some will work with you and some will not.  The important thing is to ask and see if you can lower your interest rates and minimize expenses.

3. Find Alternative Funds

You may think it’s crazy to borrow more money at this point, but the important thing to do is to lower your monthly expenses and interest rates as much as possible.  Therefore, if you can borrow money at a much lower interest rate, you should do it and use that money to pay down your higher interest loans.  The primary goal is to reduce the number of loans and the overall interest rate.

Here are some alternative funding sources that you can investigate:

• Cash out refinancing — If you own a home, you could look at refinancing your home and cash out a portion of your equity.  Use this cash out amount to pay down your high interest loans.  The caution here is that your mortgage is a secured loan, so make sure you can afford to make the new monthly mortgage payment, or you could lose your home.
• Home equity loan — This is similar to cash out refinancing, but you are taking out a second mortgage instead of refinancing your mortgage.  The caveat is the same, a home equity loan is a secured loan.  If you do this, make sure you can make the monthly payments for both your mortgage and the home equity loan, or you could lose your home.
• Personal loan – Check with your local banks and credit unions for a personal loan.  Often, they can offer you a loan at a lower interest rate than what credit card companies normally charge.  If you can handle the fees and the payment term, consider taking out a personal loan to pay down your high interest debt obligations.
• Credit card transfers — The next option is to search for credit cards that offer 0% APR on balance transfer with minimal or no fee.  Use this as an opportunity to get rid of your higher interest loans.  However, note that the 0% APR offer usually last only 6 to 12 months and the interest rates could increase dramatically.  Be sure you know what the resulting interest rates will be, and be ready to go through another balance transfer cycle in 6 to 12 months.
• Borrow from social lending networks — A relatively new source of funds are peer-to-peer lending networks, such as Lending Club and Prosper.  With both of these networks, you can borrow up to $25,000 per loan with a fixed interest rate and a 36-month repayment term.  Interest rates depend on a variety of factors including your credit score, credit history, debt-to-income ratio, and the loan amount.  Be sure to study these networks carefully before asking for a loan.  If the loan works to your advantage, take out a loan to pay off your high interest loans.
• Whole Life Insurance – If you have a whole life insurance policy, it may be worthwhile to borrow against the cash value of the policy and use the money to pay down your highest interest loans.  However, this option will lower you death benefit and significantly stunt your insurance policy value.
• 401(k) Loan — This is an option, but considers it very carefully since there are many risks involved.  If you can execute it properly, this option could be very helpful.  Read Should I Borrow From My 401k Plan? for more information.

4.  Debt Snowball

With the first three steps, you should be able to eliminate a few higher interest loans and consolidated them into other lower interest loans.  Now, it’s time to pay them off in a methodical way.  Of course, you have to make the minimum payments on all of your outstanding debt.  But what should you do with the extra money?  The answer is to use any remaining money to pay down your highest interest debt.  If you prefer the original method proposed by Dave Ramsey, you can pay down your lowest balance debt first.

As you eliminate a loan, redirect the amount you normally pay to that loan to the next highest interest loan.  This is why the method is called a Debt Snowball.  As each debt is eliminated, you can pay the next debt down with more money and keep the momentum going.

Conclusion

If you want to get out of debt, these steps can help you accomplish your goal more quickly and efficiently.  Remember the key is to change your spending habits and not go further into debt, otherwise, you debt repayment plan will fail.  Once you have your spending under control, the key steps are to (1) list your debt according to the interest rates (2) negotiate better terms, (3) find alternative funding sources to lower your interest rates, and (4) to use Debt Snowball to pay down your debt quickly.

Lastly, you can build on your effort by making more money so that you can put even more money toward debt reduction.

This article was featured in the Carnival of Debt Reduction at Rocket Finance.

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Pinyo is the brain behind Moolanomy personal finance blog and a few other web sites. If you like this article, please subscribe for free daily email updates.

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