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How to Consolidate Debt on Your Own

There is more than one way to consolidate your personal debts. You may think the only way to consolidate your debts is to use a debt consolidation company. If you think this, you may be surprised to find there are many ways to pay off debt and several ways to consolidate. Your options really depend on how serious your debt is, how quickly you want to see it disappear and your ultimate intent. Do you want to be debt-free, or do you intend to rack up new debt as soon as you eliminate the debt you have now.

Debt to be happy with and debt to get rid of

Credit card companies don't want to improve the quality of your life

If the debt you possess is for something that increases in value, don't feel guilty about it. It shouldn't gnaw at you in the middle of the night. Examples of debt to be happy with are home mortgages, college loans or higher education loans, business loans, and real estate loans.

If the debt you carry is for items that decrease in value, you should eliminate this debt and avoid creating more of it in the future.

Credit card companies don't want to improve the quality of your life. In fact, just the opposite is true. They hope you won't pay off your credit card balances in full every month. When you make just your minimum payments, the credit card companies make money in higher and higher interest rates as you get deeper and deeper into debt. If you're already stuck with this kind of debt, do what you can to consolidate or pay off these debts.

Auto loans - Most everyone needs a car, but buy within your means. You may want a Jaguar, but a late-model used Volkswagen might be the better choice.

Retail items: clothing, coffee, groceries, knickknacks - You know...the stuff we get tempted to buy every time we walk into a mall. It all depreciates the moment we walk out of the store. You should never pay interest on these items.

Retail store credit cards, these are usually a bad idea. They tempt you with a good initial interest rate or some other perk, but those may quickly turn into high interest rates and fees.

Be selective about what you charge on your credit cards. You do have more leeway if you are the type of person who pays off your credit card in full every month.

Consolidate high-interest credit card debt into a lower-interest credit card

One popular way to consolidate debts is to transfer outstanding credit card balances onto a new, lower-interest credit card (or a lower-interest credit card that you already possess). If you are considering doing this, first determine what you want to achieve. Are you consolidating to lower your monthly payments, to pay off your debt more simply, to lower your interest rate, or a combination of the three?

Check out the terms of your credit cards. Only when you understand what your current terms are and the terms of the card on which you wish to consolidate your debts can you make an informed decision about whether to pay off the debts one by one or consolidate.

You should have the terms to your credit cards tucked away somewhere. Drag them out and answer the following questions if you are thinking about consolidating. If you cannot find your terms, call your credit card issuer and ask them to mail you a copy.
  • Does the current interest rate being offered apply to any transferred balances, only to new purchases, or to both?
  • How long will this lower-interest rate last?
  • What are the late fees and over-limit fees on the new card?
  • Does this card charge balance-transfer fees? What is the amount, if so?
  • Does this card have an annual fee?
Consolidating into one lower-interest card can save you a significant amount of money, if done correctly.

If you choose to consolidate into a lower-interest credit card, you must remember to make certain the balance has really been transferred off the old card. After the new card issuer has informed you that the transfer is done, call the old card issuer and verify that the balance is now $0. Write down the names of the people you talk to as well as the dates of times of the conversations that took place. This is especially important if your plan is to cancel your old cards. Don't consolidate if you cannot pay off these debts before the lower interest rate goes up, especially if it will increase to a higher rate than you were paying before!

Get a personal loan from family members or friends

This method of getting out of debt will be easy for some and difficult for others, but if done correctly, no relationships need to be sacrificed.

The most important thing to remember is to treat the personal loan as a serious matter and the people who lend you money with respect. Before you ask a friend for a loan, you should be able to answer the following questions satisfactorily.
  • How much money do you need and why?
  • How will you pay back the loan?
  • How did you get into this bind?
  • How will you ensure that this doesn't happen again?

Of course, if the loan is a small one that can be paid off quickly, borrowing from family or friends doesn't have to be a big deal. A verbal agreement might be enough. But for large sums of money, you need a carefully thought out plan and written documents.

Having the loan clearly documented in writing will protect both sides, prevent misunderstandings and make everyone feel more comfortable. Make sure you have a contingency plan in case something happens, such as a job loss. How would you pay back your relative or friend if such a thing were to occur? Don't assume that because you're dealing with a family member or friend that you don't need to spell things out. Record the names of those who are involved with the loan, yours and the lender's. Document the total amount of the loan, the date the loan was given, the final date on which the loan will be paid back in full, the interest rate you will pay, how the payments are going to be made (weekly, bi-weekly, monthly) and the exact amount of each installment. Finally, you should pay by check or money order, never cash. You might want to get receipts as well. All of this may sound overly formal, but it is a good idea, especially for loans of a significant amount.

Borrowing from your retirement account

This is another possible way to eliminate the constant drain of high-interest debt.
Personal loans from your retirement accounts should, however, be undertaken with great thought and care. You don't want to enter your retirement years with nothing. Before you make a withdrawal from your retirement account you should understand the possible consequences of your actions.
  • Make sure your retirement account (a 401K or IRA) allows you to borrow from it.
  • Find out what, if any, fees are involved.
  • Repayments to your retirement account will be made with after-tax dollars from your paycheck, although your original contributions were made with pre-tax dollars. And when you start withdrawing at retirement, you will again pay taxes. Figure out, if possible, if it is worthwhile to pay off your high-interest debt through this method.
  • Borrowing from your retirement account makes it harder for the remaining funds to grow in value. Some people, not wanting to contribute to their retirement account while they pay back their loan, make things worse by suspending the regular contributions.
  • If you were to quit or lose your job before the loan is paid back, you would be required to settle the loan quickly, sometimes within 30 days. If you cannot, the outstanding balance will be written off as an early withdrawal. In this case, the money is taxed as regular income and you get stuck with the 10% tax penalty (unless you are 59 or older).
  • You must be careful not to run up more high-interest debt. If you do, your situation will only worsen.
There are advantages to borrowing from your retirement account that may make this option the ideal solution for you.
  • Assuming your retirement account allows you to borrow from it, you can get the loan at a good interest rate: usually only 1 or 2 percent above the prime lending rate.
  • This method doesn't require you to involve any outside parties, which can dramatically simplify things.
  • Generally, borrowing from your retirement account requires only minimal costs and fees, and you don't have to endure the hassle of a credit check.
  • Because your repayments are set up through payroll deduction, it is easier to budget for the payment. You don't have to mail in a check because it comes right out of your paycheck.
The amount you can borrow from your 401K is usually up to 50% of the vested balance, as long as that amount is below $50,000. Generally, you are required to pay back the loan within five years, but you may be able to take longer if the loan is for the purpose of buying a home.

If you are slogging along making minimum payments on a high-interest credit card bill, then borrowing from your 401K at a low interest rate might be a smart move to make, as long as you remember not to charge up your cards again until the loan is paid back.

Borrowing from your life insurance policy

This works for people who have whole life insurance, which builds cash value over time. Check out the policy to see how much cash value you have built up. Borrowing from a life insurance policy has only one drawback, if you do not get the loan paid back before you die, your beneficiaries will receive a reduced benefit. The insurance company will keep the balance they are owed. Besides this consequence, this type of loan is fairly painless. You are not required to pay it back at all. It's up to you.

Borrowing from a credit union

These institutions generally offer lower interest rates than banks. Their fees are also generally lower than those charged by banks. If you are not automatically eligible to be a member of a credit union through your work, check around. Some credit unions allow relatives of members to join, and you might be eligible through some other organization.

Working with a credit counseling agency

If you feel like your high-interest debt is getting out of hand, it might be worthwhile to give a credit counseling agency a chance. These organizations consolidate high-interest debt. After you pay them a certain amount every month, they turn around and pay your creditors. If you find yourself overwhelmed, this could be the right option for you as credit counseling agencies work with your lenders. They can often get interest rates lowered and eliminate late fees.

Negotiate with your lenders

This may or may not work, but it is always worth the effort, especially if your debt is getting serious and you're afraid your credit score will be affected. The last thing creditors want is for you to declare bankruptcy. If you can explain to them how your debt happened and why you need this renegotiation, they may agree to lower your interest rate, waive your late fees or alter your payment schedule.

A note about canceling credit cards

It may be your plan to cancel your credit cards once you get them paid off so that you cannot charge yourself into debt again. There are two ways of looking at this.

One method, if you think you cannot trust yourself to avoid debt in the future, is to pay off the credit card and then cancel it. The common advice is:
  • Pay off any card you are planning to cancel, and when the balance reaches $0, cancel the card.
  • Keep one, two or three credit cards in case of emergencies. Don't carry them in your wallet. Make sure the limits on them are enough to cover emergencies.
  • You should know that there could be unforeseen consequences to canceling a credit card.
  • Your credit history will be lost. The three major credit reporting bureaus keep records of your credit history. Your oldest credit cards show how long you have had credit and how you handled it. If you cancel them, your credit score could go down because that history is now gone. Consider carefully whether to cancel cards or put them away in a safe place.
  • If you decide to put your cards away, monitor the monthly statements and notices you get in the mail. If you receive a notice that your account has changed and you are going to be charged an annual fee because you don't use the card, then it might be time to consider canceling or using the card minimally to avoid the fee.
Knowing your options, you should be better able to choose and take the financial route that best benefits you. You can do it yourself, you can contain and eliminate your damaging debt.

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