Debt consolidation is a total trap! Or is it? The real answer is: it depends. You see debt consolidation is one of those really tricky things that if you do it right, it'll save you thousands of dollars in interest payments and countless headache. That's why you see it advertised all over the place like it's some sort of magic pill. ...it's not by the way.
But if you do it wrong, it can get bad. And I mean really, really bad. I mean thousands of dollars, there goes your credit, oh wow, there goes your house, kind of bad. And if you don't pay attention to every little detail about the process from start to finish, you will end up on the bad side of the deal every time. So today we're breaking down the pros, cons and pitfalls of debt consolidation, so that you can make sure that your process is a money saver instead of a money pit. Hey Dreamers and welcome back to my channel, where we break down all things money so it can stop being an obstacle and start being what it is: a tool to help you build a life that you truly find worth living. Now, before we start walking through the pros, the cons and the pitfalls of debt consolidation, let me introduce myself to the new folks in town. I'm Tiana B. Clewis, an author, speaker, and coach who has dedicated her life to helping women entrepreneurs transform their relationship with money so they can grow their income, dump debt, and start building a lifestyle that they've been dreaming about...
While still having some fun along the way. Believe me, when I say that you actually can't eliminate your student loans and take your kids to Disneyland - although I wouldn't do it right now - at the same time. I've done it and so have my clients. If you want to join me on this story, like this video and follow my channel by clicking the big red button below. Then hit the bell to make sure you're notified when I drop new money tips and strategies each and every week, that'll help you hit your financial goals while still enjoying life. Now let's talk about debt consolidation. First things first, what does debt consolidation actually mean? Debt consolidate is when you take multiple debts, you combine them all into a single debt. Once they're combined, you only have one debt, one lender, and ultimately, one monthly payment. Now the thing is that the total amount of the debt that you owe doesn't actually go down. But the consolidation process can be really helpful for a variety of reasons.
Reason one: now that you only have one monthly payment to make, it's easier to budget and manage the flow. There's no more using calendars and shuffling around money to make sure that each debt gets paid on time through the individual portals, only to actually risk missing one and accidentally failing to pay it on time... because despite the fact that it's 2020 and technology is cheaper than ever, some of the companies still don't have auto pay options or even electronic payment portals. But with only one that's a minute, at least all of those concerns are no longer a problem. Reason two, is that now that you only have one company to deal with, life becomes easier when there's an emergency. If you lose your job or get sick and can't work for a while, you only have to worry about one company.
And as long as that company has plans in place to help in times of hardship, you can call up one company to negotiate with instead of like seven. Reason number three, which is the benefit that's most important to me, is that if you do it right, you're going to save money over your repayment period, because you snagged yourself an overall lowest - lower interest rate. And that's what we always want. But notice that I said, "If you do this debt consolidation, right." You've probably heard from some big name money gurus that say debt consolidation is a terrible idea.
Ultimately they say this because it's really, really easy to mess up. If you do it wrong, you'll end up with more debt, pay more interest in the long-term, or even risk losing your home. And it's not because people are just dumb or uneducated. It's just because there are lots of details that you have to pay attention to. And the folks guid- guiding you through the process aren't typically inclined to help you see all those details. In fact, in some cases, they'll try to steer you away from looking at some of them too closely. So that means that you have to be extra vigilant. Now, before I get into those issues, I have to take a moment to give you some really important caveat about debt consolidation. The first caveat is that in most cases, you can only consolidate unsecured debt. Unsecured debt is anything that doesn't have collateral - or some kind of material good, physical good - attached to it that can be claimed by the bank if you fail to pay the debt as agreed to.
Well on a mortgage, the collateral is the house. That's why banks will foreclose on the house if you fail a bit in the mortgage. Or on a car loan, the collateral is the car. Hence the dreaded repo man. Now for a lending institution, a secure debt is a much safer bet because they have something that they can physically take away and sell, if you don't pay up. But on something like a student loan, where there, no collateral, it's just your word that you will pay off the debt.
Now, in the case of debt consolidation, those loans are typically unsecured. So in many cases, a secured debt, like a car or a house gets left out of the consolidation process because the lending institution doesn't want it take on that risk without adding the collateral in as well. Now, to be clear, there is such a thing as a secured debt consolidation. So It's possible to get a car loan, a boat loan, or even a mortgage included in the new loan. However, they're going to want to that car, boat or house as collateral against that loan. I say all that to say that for most people, debt consolidation is still going to leave you with a couple of leftover debts to manage, like the car or your mortgage.
But if you really want those things included in the consolidation, at least, you know now that you can specifically look for a lender that offers secured consolidation loans. The second caveat is that the terms of your debt consolidation loan is going to be heavily influenced by a combination of your credit score, your income, and what the Federal Reserve is doing with interest rates. If any of those things is not going in your favor, like your credit score is going down instead of up, that consolidation is probably not going to get you in an interest rate low enough to make it worthwhile. Now, if you want a breakdown about what should be happening in each of those areas and why, you can check out episode 112 of the Dreamers Financial Playbook podcast, or the video on my YouTube channel called "To Refinance or Not | When You Should Refinance Your Loan." There, I break down each of those elements, why they matter, and what you should be looking for. All right, so at this point, I really want to talk about where things can start to go wrong in the debt consolidation proces,.
But I have one more thing I have to mention. As I was writing this out, I realized I have way too much to cover it in order to make this a single episode. As you've likely noticed, I've been trying to cut my time down from an average of 35 minutes to about 10 to 15. And that's just for the sake of your attention span and your super busy schedules. That means that this has now officially become a two-part mini series situation. So be sure that you come back next week to get more ways in which all of this can go wrong and have to protect yourself. Cool? You good? Alright. The first place where something could go wrong in the debt consolidation process is when you're choosing how and with whom to consolidate your debts.
Like everything else in finance, there is more than one way to skin this proverbial cat, but some of those ways are super risky and are likely to cost you a lot more money in the long run. And well, you know, me, I am not about spending more money on debt than you absolutely have to. So I want you to pay really close attention because I'm about to break down each of these methods, starting with my least favorite. My least favorite method happens to also be an insanely popular one: using a new credit card with a 0% introductory rate. If you're using a credit tracker like Credit Karma, or one of those money management app, like a Truebill or a Clarity Money, you've probably seen this presented as a good option for you on multiple occasions.
These companies will often encourage you to,consolidate your debts to improve your credit score or to lower your monthly payment. What they don't tell you though is why credit card companies are happy to give you that 0% introductory rate, assuming you qualify, in the first place. Now there's a lot of elements to this that I probably need to do a separate video to break down fully, but ultimately, most people are not going to pay off the entire balance of the debt before the introductory rate ends, which they know. The problem with not paying it off before the introductory rate ends is that you now have to contend with that typical interest rate of anywhere from 15 to 26%. When you consider the fact that many personal loans and student loans have rates far below that number, you can see why this is huge problem. In the long run is going to cost you thousands of extra dollars in interest. Now here's something else that can easily be missed. Some of those credit cards that are advertised as 0% introductory APR is, are not being upfront.
There have been some instances where the cards making that claim actually deferred the interest during that introductory year. So if you picked a cart that wasn't being upfront or clear about its terms, you may find yourself being hit with a massive interest charge during year two, for interest that would have been paid on the monthly balances during that introductory year. So for those two reasons, I strongly discourage anyone from using a credit card for debt consolidation, even if the interest rate is set at 0% for the first year.
And even if you actually can qualify for it which most people don't. Another popular method is targeted specifically at home owners like myself. Some lenders will actually encourage you to use a home equity loan or open a home equity line of credit, known as a HELOC, to consolidate your debts. With both of these the banks are lending you money against the equity that you have accumulated in your home. So the equity is the difference between how much the house is worth, what others will pay for it and how much you owe on the mortgage. So if you own a $300,000 house, have a $200,000 mortgage, then you have a $100,000 in equity.
The difference between the home equity loan and the HELOC is that the HELOC is a line of credit, similar to a credit card. You can charge up a certain amount, pay the balance down and then charge it back up. Whichever one you choose, we still end up with a problem because both of them are using the house as collateral.
So if you fail to make the payments as agreed on either of those, the lender can foreclose on your house. If you've been following me for a while, you know that I'm always against anything, that's going to put your house at risk. I strongly believe that if you can at least keep a roof over your head, you can figure out the rest, like anything else, during the toughest of times. So when it comes to debt consolidation, or really anything for that matter, stay far, far away from HELOCs and home equity loans, because they put your house, where you lay your head at risk. Another method, which I consider to be far more acceptable, but still again, not my favorite, is a loan from your retirement account. Most retirement accounts have clauses that allow you to take out a loan from the account up to a certain percentage of the balance. It's a way to leverage the cash sitting in the account without having to actually pay a bunch of fees and tax penalties for early withdrawals, which we know those fees are no joke. The lovely thing about these loans is they often have insanely low interest rates and favorable terms all around.
Also you're using your own money, not someone else's, so when you're paying it back, it's kind of like you're paying yourself. But if that sounds too good to be true, that's because it is. There are two many problems that we have with this one. The first is that the rules of the loans is governed not only by the institution managing the account, but if it's through your employer, there can also be another set of rules tacted on by them. That means rules can vary widely and you need to know all the details fully before you take out the loan and those details aren't always the easiest to find.
So here's some examples. Now there are some retirement plans that will allow you to take on a loan at any time, for any reason, up to a certain percentage of the account balance. But the same plan with the same institution, but a different employer may have a predetermined list of when you can take out a loan. Some retirement plans allow you to pay above and beyond the minimum monthly payments so you can pay it off early, but some don't. Some require automatic ACH transfers for the payments while some, let you hit a pay now button when you want.
And for others, you can pay the entire loan off in a big lump sum early and for others, you can't. So, if you're willing to chance using this method, read all the rules very carefully and make sure that you actually have all the rules to read in the first place. The other problem is that you lose the growth you would have gained while the loan is out.
When you take a loan from a retirement account, they have to sell off shares of the stocks, bonds, and mutual funds that you're invested in to provide you with the actual cash. So if those investments go up while you have the loan out, you've now missed out on the growth because you sold off those particular items. This is why you're often advised to just let the money stay in the retirement account no matter what, because ultimately, the stock market is going to go up. Even in periods of recession, like now, when you ride it out, the stock market always rebounds. Now it may take a year or two, but I promise you the sucker's coming back. So again, this method is still better than the first ones in many ways, but ultimately, it's still not ideal. Another option is for those people who have a whole life insurance policy with a big cash value. Many of those policies have terms that allow you to take out a loan against the cash value of the policy, which you can then use for debt consolidation.
It's similar to the loans from retirement plans, where you get really low interest rates and often super favorable repayment terms like the ability to straight up stop repaying the loan, if you want to. Also if your policy is set up right, the cash value of the policy will continue to grow even while the loan is out. If you've ever heard anyone talk about being your own bank, this is exactly what they're talking about. In fact, you can get more information about this concept, an episode 82 of my podcast or look for "Demystifying Self-banking with Mark Willis" on my YouTube channel. I interviewed him. We talked all about the concept right there.
Now, remember that I said, if your policy is set up right. It's actually one of those warnings that Mark put out there in our interview. There's a lot of insurance brokers out there selling policies that claim they have these features, but aren't actually set up properly. As a result, there can easily be hidden fees and even tax penalties when you take off the loan. So once again, you have to read all of the fine print so that, you know the rules.
We're down to the final method, the one that I actually recommend for you, if you really want to do debt consolidation in the safest way. Just go to a bank that you trust and get a personal loan with a low interest rate. Now I'm a fan of using credit unions and local regional banks because they usually give better interest rates and terms than the big national and international banks. But notice I said usually not always. Either way, you're definitely going to want to shop around on this one. Now under their personal loan options, it's common for a bank or lender to have a debt consolidation option. What usually ends up happening is that during the process of getting the loan, the bank gathers information about all of your debts that you want to pay. And if you're approved and agree to accept the loan, the lender will pay off all those debts on your behalf, leaving you with just the consolidated loan from that lender. Now, as I mentioned before, there are options for secured debt consolidation, where you have to put a collateral for the new loan.
In those cases, you ideally wants to include your other secured debt into the consolidation and use the collateral from the old debt for the new consolidated debt. That's just the simplest way and safest way to do it. You also want to make sure that you're going to get a fixed interest rate, that at the end of the loan, you're going to end up paying less interest, and a bunch of other things... which is exactly why there's going to be a part two. So, as you can imagine, I'm going to stop right here because I've already given you a lot to think about when it comes to understanding debt consolidation and what your options are. The last thing I want to do is overload your brain with too much debt consolidation information too fast.
So we're just going to give you a little time to think about it and let your mind rest for a bit. But I still want you to get the rest of the information. So join me next week when we dive into several ways, you can avoid taking on more debt or paying extra interest during and after the debt consolidation process. But before you go, I wanted to talk to you about something that's pretty darn important. For some of us, things like refinancing loans and debt consolidation end up sounding super tempting because we think that if only we could get ahead on these dag-gone debts, then we'll be fine. But as you've probably picked up during the video, that may not be the best game plan for you. It can easily go wrong. But you still find yourself entertaining the idea, because honestly, you don't really know where to start to fix your money woes.
So you're really guessing on whether you need to focus on the debt through consolidation, refinancing, or something else. The truth is you might have an income problem. Or it could be that you have a sale things problem that just won't let you be great. Or maybe it really is the debt. Well, it's time to stop guessing. I've pulled together a quick guide to help you pinpoint exactly where you should focus your financial efforts, because when you know where to focus first, you can eliminate all those random attempts that get you absolutely nowhere. To get your hands on my free guide, I want you to head over to tianabclewis.com/sanctuary and join the Dreamers Financial Sanctuary group. That's a Facebook community of a fellow women entrepreneurs using their hard-earned cash to dump debt, save money and create the life of their dreams. You'll easily find the guide pinned to the top of the group for you to download. Also, don't be shy. Go ahead, introduce yourself in the group.
The group members and I would absolutely love to get to know you on your journey as we are getting super focused and making things happen together. But wait, before you head over to the group, let me know that you found this video useful by hitting that thumbs up below and subscribing to my channel. Don't forget to hit the bell so you're notified each week when I drop brand new money tips or strategies that are going to help you use your cash to do all the things we just talked about: dumping debt, saving money, building your daily life and doing it without sacrificing all the fun.
Finally, if you're looking for more information that will help you transform your debt into a distance memory faster than you ever thought possible, these videos are exactly what you need. With that you get to watching these videos and I'll see you next week. Bye bye..