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Debt Consolidation Facts

1. If you spend more than 50% of your credit limit every month, this indicates to the Credit Bureau that you do NOT have enough cash on hand to meet your monthly expenses. This will identify you as a high credit risk and will actually reduce your credit score by 60 - 70 points overnight (Fair Isaac).

2. If you miss 1 or 2 payments on your credit card debt, the issuing company will skyrocket your interest rate to a whopping 27% - 30%!

3. Out of a random sample of 3 million American consumers (included in Experian's National Score Index), 51% of them have at least 2 credit cards and 14% of them have 10 or more credit cards.

What is Consumer Debt Consolidation?

Debt Consolidation is the technique of gathering several credit card debt, loans and other liabilities and combining them into one. A debt consolidator thus consolidates all of his debt by taking out a single loan to pay off the debt as a whole. Debt consolidation allows you to combine all of your loans into one loan, usually at a lower negotiated interest rate.

Facts about Debt Consolidation in America

  • According to the Federal Reserve Board, debt in American households has reached the $2 trillion mark, excluding mortgage debt.
  • US households with at least 1 credit card had $9000 debt per each credit card owned. So if a typical household owned 3 credit cards, they would be in $9000 x 3 = $27000 in debt.
  • According to the Bank of England, the consumer debt in UK has topped the £1-trillion mark.

Video: How to Settle Credit Card Debt on Your Own

Example of Debt Consolidation

Assume you have $35000 worth of unsecured debt. One debt is a 2 year $15,000 loan @ 10% APR while the other debt is a 4 year loan of $20,000 @ 12% APR. This means you have to make debt payments of $750 on the first loan while making payments of $617 on the 2nd loan. This means your total monthly payment on these debts is:

Debt Consolidation Loan #1 ($15,000 Principal @ 10% APR for 2 years)

Outstanding Debt: $15,000
APR: 10%
Annual Interest = $15,000 x 10% = $1500
Monthly Interest = $1500 / 12 = $125
Monthly Premium = $15,000 / 2 / 12 = $625
Total Monthly Payments = $625 + $125 = $750

Debt Consolidation Loan #2 ($20,000 Principal @ 12% APR for 4 years)

Outstanding Debt: $20,000
APR: 12%
Annual Interest = $20,000 x 12% = $2400
Monthly Interest = $2400 / 12 = $200
Monthly Premium = $20,000 / 4 / 12 = $417
Total Monthly Payments = $417 + $200 = $617

The total monthly payments on the debt = $617 + $750 = $1367. If you approach your debt consolidation company, they will tell you that they can lower your APR to only 8% and combine both your monthly payments and make it only $750 per month. This means you will be able to save:

Savings = Pre-Debt Consolidation Payments - After-Debt Consolidation Payments
Savings = $1367 - $750
Savings = $617

Who wouldn't not want to save an extra $617 per month?! However, the debt consolidation company will NOT tell you that you have to keep paying this $617 per month for 6 years. Here's the cost-benefit analysis:

Pre-Debt Consolidation Payments:
$750 x 12 months x 2 years = $18,000
$617 x 12 months x 4 years = $29,616

After-Debt Consolidation Payments:
$750 x 12 months x 6 years = $54,000

If you did not consolidate all your debts, you would have paid $18000 + $29616 = $47,616. After debt consolidation, you would have paid $54,000. Notice that you are actually paying more on the loan after debt consolidation than before it. The difference amount that you will be paying is $54000 - $47616 = $6384.

Now you know why debt consolidation companies are still in business? Because they are making money off you!

What is Debt Consolidation?

what is debt consolidation?Debt Consolidation takes all of your debt, loans and liabilities and moves them into 1 account under 1 standard low interest rate. Some of the debts include:

  • Personal loans
  • Home Equity loans
  • Credit card debt
  • Mortgage debt
  • Car loans

If carried out properly, debt consolidation will result in a lower annual interest rate, lower monthly payments and therefore more disposable income for you every month.

Pitfalls of Debt Consolidation

While there will be some people who use debt consolidation to really pay off their debt, most people won't. For example, immediately after consolidating all of their debts into one, most people will go on a shopping spree and max out their credit cards. What happens next? They're in debt again!

Actually, it is estimated that 78% of debt consolidators see their debts grow back to original levels after the original consolidation. This is because these consumers have less savings, bad spending habits and no real determination to get out of debt.

Debt Consolidation Advice

Reducing your total debt owed month by month is critical for your debt consolidation program to work. Experts in the finance industry suggest that your outstanding debts (that includes credit card & mortgage debt) should NOT exceed 36% of your Gross monthly income. This 36% is also referred to as the Debt-to-Income ratio.

Debt to Income Ratio =
Amount of Money Paid to Debts Outstanding / Total Income Earned

For example, if you spend $1500 a month to pay off your car loans, mortgage payments & credit card debt while your monthly income is $3000, then your debt to income ratio is:

Debt to Income Ratio = 1500 / 3000
Debt to Income Ratio = 50%

Most people who calculate their debt to income ratio are surprised that their percentage is much higher than the suggested 36%

Using Debt Consolidation to Improve Credit Rating

Many American households are in deep debt. Studies have shown that over 40% of American families spend more money than they earn (income) and that the average American household is in $10,000 credit card debt. Note that this does NOT include car loan debt, mortgage debt, student loans, etc. If you have a bad credit rating, debt consolidation might just be the financial program you need to improve your credit.

debt consolidation success

Debt Consolidation is also known as debt reduction because it consolidates all of your unsecured credit card & other debt into 1 payment. For example, consider this scenario where the consumer owes debt to several credit cards. The hypothetical interest rate (APR) is also indicated:

Credit Cards

Debt Owed

Interest Rate

Visa

$4500

19% APR

MasterCard

$8000

12% APR

American Express

$1000

15% APR

Trust Union

$2000

10% APR

After the debt consolidation program, the above hypothetical schedule would look like this:

Credit Cards

Debt Owed

Interest Rate

Debt Consolidation Lender

$15,500

8% APR

This means you will not have to keep track of the 4 separate bills each month; Visa, MasterCard, American Express and Trust Union. You will have to only make 1 single payment every month to your debt consolidation lender with a lower APR of 8%.

Video: Be Aware When Choosing a Debt Consolidation Company

Debt Consolidation Trivia

1) According to the Federal Reserve Board, debt in American households has reached the $__ trillion mark, excluding mortgage debt.
a) $1 Trillion
b) $2 Trillion
c) $3 Trillion
d) $4 Trillion

2) US households with atleast 1 credit card had $____ debt per each credit card owned.
a) $7000
b) $8000
c) $9000
d) $10,000

3) Americans carry about $____ of credit card debt from one month to another
a) $4500
b) $5500
c) $5600
d) $5800

4) If carried out properly, debt consolidation will result in:
a) Lower interest rate
b) Lower monthly payments
c) More disposable income
d) All of the above

5) It is estimated that __% of debt consolidators see their debts grow back to original levels after the original consolidation.
a) 52%
b) 64%
c) 72%
d) 78%

6) Experts in the finance industry suggest that your outstanding debts (that includes credit card & mortgage debt) should NOT exceed __% of your Gross monthly income.
a) 25%
b) 35%
c) 36%
d) 42%

7) The average American household is in $_____ credit card debt
a) $8000
b) $9000
c) $10,000
d) $11,000

8) Studies show that over __% of American households spend more money than they make per month:
a) 25%
b) 30%
c) 35%
d) 40%

9) A home equity loan draws on the equity built in your home as collateral. This means incase you fail to make your monthly payments, the bank can possess your home (collateral).
a) True
b) False

10) If you want to pay off your credit card debt fast, you should:
a) Pay Off Higher APR Credit Cards First:
b) Make Paying Off Your Debt Your #1 Priority
c) Resist Impulse Buying
d) All of the above

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