Wednesday, June 18, 2008

Learn the lingo: Debt Consolidation

Before I began learning about finance, it was the terms involved that seemed the most intimidating to me, and I know I'm not alone. With words and acronyms such as "EBITDA," "managed futures," "margins" and "tax-deferred income," it can seem like a whole other language! And with a language that sounds so....well, boring.....why would you want to learn how to speak it, right?

Believe it or not, all those boring terms are actually relevant to your life. If you ever want to 1.) invest in the stock market, 2.) learn ways to legally shelter your income from excessive taxes, 3.) buy a house, 4.) apply for a loan, or 5.) find a mutual fund to manage your investments, among countless other things that pertain to your money, you need to learn the lingo. So, without further ado, here's the first of my daily definition series. . .

Debt Consolidation:

Debt consolidation is when you do just that: consolidate (or merge) your debt into a single loan or debt. Let's say you have three loans, totaling $13,000:
  • A high-interest Macy's credit card, with $3,000 left to pay off,
  • a high-interest Bank of America (BofA) car loan, with $8,000 left to pay off,
  • and a low-interest Washington Mutual (WaMu) credit card with $2,000 left to pay off.
Since three out of your two debts are high interest, consolidating them under one umbrella, such as your WaMu credit card, makes more sense because you'll be paying a lower interest rate on your combined debt of $13,000. I know what you're already thinking -- why would WaMu want to assume responsibility for the $11,000 I have in car loans and Macy's credit cards?
Simple! What basically happens with debt consolidation is that WaMu agrees to pay off your car loan and credit card entirely, but then you owe WaMu the amount they paid off ($11,000), plus a lower interest rate than what you would have paid to BofA and Macy's. WaMu is cutting you a deal of sorts: by owing them the money instead of BofA and Macy's, they are rewarding you with a lower interest rate, which saves you lots of money you'd have otherwise been throwing away on higher interest rates. Debt consolidation is also a great thing because it allows you to pay off your unified debt with one payment every month, instead of three separate payments (in this case). With this increased organization, it encourages you to remember paying your single bill on time every month.
The downside to debt consolidation is that it frees up credit cards that were otherwise full, tempting you to start spending with them again, but resist temptation and pay off your existing debt first!

1 comment:

LittleStar said...

If you have decided that you want to consolidate your debts, the choices you will face could quickly get stressful and overwhelming. Given the risks of losing your home and amassing debt, it's wise to proceed with caution.

Blog Widget by LinkWithin