Debt consolidation consists of organizing your debts and then consolidating them thru pay down or taking out a consolidation loan. It is a key element in financial planning techniques.
Organizing your Debts
The first step to a well thought out financial plan is to
create a budget
and then stick to it. A good budget will show you where you can cut back expenses that can be used to reduce your debt load. Freed up money accelerates debt reduction.
There is excellent budgeting software to help organize your debts and free up monies. If you haven’t done this type of analysis before, the software is a great way to go.
Or, if comfortable you can set up your own spreadsheet. Below is a simple example to show how this is done.
• Your creditors.
• The balance of each debt.
• The interest of each debt.
• The minimum payment.
Note: You will probably exclude your home from this list. It usually makes sense to pay other loans off first. Also, it is due to the size of the loan, the tax savings (if you itemize) and low interest rate (if you have refinanced in the past couple of years).
Next, sort your highest interest debt at the top. The next column should be your second highest debt and so forth.
Example of Debt Organization
Paying Down Your Loans
With freed up money from your budget you can pay down your debts that you have defined in doing debt consolidation.
To get more bang for your buck determine which debts to pay down first, second and so forth. A rule of thumb is to add money to pay of your bad debts first, then concentrate on your good debts.
• Pay off high interest unsecured loans first.
• Pay off secured loans for depreciating assets second.
• Pay off good debt such as business loans, or appreciating asset loans third.
As you pay off each debt that will free up more money to pay down your other debts. You get a wonderful financial snowball effect from this process. It starts slow, but picks up speed over time (as long as you stick to your new budget).
Note: If you have some relatively small loans (that you can retire quickly) consider putting some of the extra money towards paying them off. This is another way of freeing up more money for the snowball effect.
Debt Consolidation Loans
You may want to consider a consolidation loan—but only if it is to your advantage. Consolidation loans are taken out to secure a lower interest rate, a fixed interest rate, for servicing just one loan or a combination.
Consolidating loans makes them simpler to manage. However, these loans are a two edged sword. Beware of un-reputable companies and their scams. Also, be careful of the trap of freely spending again if a debt consolidation lowers monthly payments and the wealth effect (a sense of extra money) kicks in.
Final Thoughts – Debt Consolidation
Debt consolidation isn’t easy. As a matter of fact, it can take a significant amount of time.
However, it is a foundational element of every
The benefits far outweigh the drawbacks. Taking control of one’s debts means you will be better prepared to weather economic storms, and personal/professional setbacks.
Too many people live paycheck to paycheck. Many augment their lifestyle with debt. The moment they have any hiccup in their financial or personal situation (illness etc), or the economy turns sour, they are in financial trouble. Having a financial pad starts with eliminating debt and then putting money away for that inevitable rainy day.
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