Low Interest Debt Consolidation Loans
Low interest debt consolidation plans excite many people who feel permanently indebted to high interest debt. The promise of low interest debt consolidation loans is simple: sign up, reduce your interest rates, monthly payments, and pay your bills off faster.
Alas, there are few better ways to make a dent in your debt beyond controlling the rate at which it grows. Credit cards, which frequently charge 18% per year, can double your account balance every four years. After twelve years of a reckless indebted state, the debts have grown to eight times their original size. That means a $2,000 vacation package may very well cost you up to $8,000, $6,000 of which is pure interest, and interest on interest.
The power of compound interest has made many millions of people rich, just as it has made many millions of people poor. Obviously, when you invest at an 18% annual rate (as the credit card companies do when they lend to you) it’s hard not to become excessively wealthy. Just imagine if you could earn $180,000 per year on a $1 million investment. Even better, $90,000 per year (almost six figures) starting with only $500,000.
Let’s get down to why you might choose to consolidate your debts:
1. Lower monthly payments – if you manage to decrease your interest rates, then the monthly payment will also drop, while allowing you to pay off the debt in the same amount of time. This is a great way to fix budget problems that arise when your outgo exceeds your incoming funds.
2. Reduce total costs – Lowering your interest rate is a great way to reduce your total interest burden. To showcase this example, we’ll use a $10,000 credit card debt. At 16% interest, you would pay $243.18 per month to pay off the loan in five years. However, in reducing the interest rate to 6%, the monthly payment falls to $193.33. Total savings over the period of five years is $3,000, which would make a great starter for a savings account.
3. Better tax favorability – Often ignored in the financial conversations are the benefits of debt as it relates to taxes. Some interest incurred on debt is tiny—car loans are routinely made at 2.99%--but they have no tax benefits. On the other hand, it is possible that a loan at 5% might be better than this 2.99% loan after accounting for taxes.
The Payoff Approach
In general, paying off your balances with a low interest consolidation loan will require that you formulate an approach for paying off the loan. You need a plan.
First and foremost, we need to decide what your goals are:
- Pay off debt the fastest
- Pay off debt the cheapest way
- Reduce monthly payments
You see, paying off debt the fastest is usually best done by getting an open-ended line of credit from a bank and using the line of credit to pay off your current, high interest creditors. From there, you have only one monthly payment on the new loan, and you’ll have reduced your interest expense by leaps and bounds.
Paying off debt the cheapest way possible entails some clever use of tax credits available to homeowners. If you currently own your home, then you know that there is a tax credit for all the mortgage interest you pay on your home. Additionally, you should also know that this tax credit applies to second mortgages. So where’s the upside? Well, should you take out a second mortgage to pay off your high interest debt (second mortgages are generally very low in interest rates) then you’ll not only get a lower monthly payment, and a lower interest rate, but also a tax credit for all the interest you pay on the second mortgage. Keep in mind that consumer debts—credit cards, car loans, etc—do not enjoy similar favorability with the IRS.
Reducing monthly payments is for people who have current budget issues. Maybe they lost an income, or they just want to be able to make a trickle of payments, so long as the amount coming into their budget is more than that which is going out. Makes sense. So there are two ways to reduce your monthly payments. You can agree to extend the loan terms—turn a 4 year loan into a 7 year loan, for example—or seek lower rates of interest. It is recommended that you do not make loans longer than you have to, and extending them will increase the total amount you pay over time. If you’re currently very past due on a number of debts, see if the debt collectors will settle the debt for a partial payment—you never know until you ask.