Factors to Consider When Consolidating Debt

At the office the other day a colleague asked me to analyze his refinance decision and while we getting deep into the calculations (taking into account taxes, remaining interest, etc.) I started to think about things to consider when deciding to consolidate one’s debt.  I don’t think refinancing one’s main home is as easy as a decision as calculators make you believe, and similarly choosing to consolidate your debt may not be as easy as a decision as others make you believe.

I remember the first step I took when getting my financial house in order: consolidate my debt.  I felt it was important that I was able to move all of it to a zero percent credit card so I could take advantage of paying the least amount of interest, however,I think there are other factors to take into consider.

3 Factors to Consider When Consolidating Debt

I think when people decide to consolidate their debt they are only looking at the interest rate, however, there are other factors to consider:

Fees

I am not sure if it was ever possible to consolidate one’s debts, specifically consumer debt, without fees and additional expenses.  I am not sure it is a good analogy but when my colleague was considering his refi there were an additional $6,000 in fees that had to be taken care of.  Many times when you are consolidating consumer credit there are fees, and I am sure there are similar fees when you are dealing with personal loans to cover all different types of debt.

Amortization Schedule

While it may not be pertinent if you are dealing with the consolidation of consumer credit card debt, but if you are working with an amortization schedule knowing where you are on the timelines is crucial.  An amortization loan is

a loan with scheduled periodic payments of both principal and interest. This is opposed to loans with interest-only payment features, balloon payment features and even negatively amortizing payment features

When you begin an amortization repayment schedule the interest is a much higher percentage of the payment (could be 95%+ of the payment), and conversely, towards the end most of your set/steady payment is mostly principal.  As such if you are deep into your amortization loan repayment it actually may be detrimental starting from the beginning! This MUST be taken into account when figuring out whether it is worth it to consolidate.

Promotional Terms and Restrictions

Lastly, prior to consolidating any debt one should read and completely understand any promotional materials about the debt consolidation loan.  Some questions to ask include:

  • How long is the promo period for?
  • What happens if I don’t pay off the balance prior to the end of the promo period?
  • What happens if more debt is incurred during the promo period?

Am I missing any other factors?

5 Responses to Factors to Consider When Consolidating Debt

  1. I’ve never consolidated anything before but these are some good tips for people looking into it. What about over payment and extra payment terms, I’ve heard these can sometimes vary. Like on my car loan (just a small one) a few years ago, I was adding a little extra each time and instead of applying it toward the principal, they sent me a check back—weirded me out. ;-)

  2. Evan-

    Most people don’t think about how a loan is amortized, although it’s extremely important. I generally dislike rules-of-thumb (ie. refinance if you’re dropping 1%). As long as you sit down and actually crunch the numbers instead of getting caught up in the comforting words “lower payment” “save money,” you’ll be fine. Lastly, it’s important to shop around. Some processes will cost you 6k and take 6 months while others will cost $200 and take 2 weeks. The headache factor is definitely a variable to consider.

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