Being new to something can be bewildering. You don't know if you are getting hoodwinked or helped by a slick sounding salesman who is offering you a solution for your life crippling debt. You simply have to get educated on the topic yourself so that you can filter out their crap and make the best possible decision for you and your family.
There several point of information that are really going to be important when evaluating a debt consolidation loan: the loan interest rate, the loan term, and the loan fees.
Understanding Loan Interest Rates
An interest rate is the essentially the amount of money that you pay your lender for the right to borrow money. So if you have an interest rate of 6% you will pay around $6 for every $100 that you borrow from someone. The reason that I say about is that there is a lot that goes into calculating how much interest you pay on your loan.
One of these things is the compounding period. A lot of loans are going to compound and accrue daily - this means that the interest that you owe on a loan gets added to the amount you owe every day. This generally means that you end up paying slightly more than 6% interest over the course of an entire year because you begin to pay interest on interest, a process called compounding in financial circles. You can avoid the compounding effect by making a payment everyday - but who it going to do that!
The key factor in determining how much interest you are going to pay is the rate of your debt consolidation loan. The higher your interest rate, the higher your monthly payment is going to be. I have explained how a debt consolidation loan is a cash flow management tool, and making sure that you get a low interest rate is going to be the deciding factor in just how low your monthly payment is. To see this, take a look at the following table I put together:
| Yearly Interest Rate | Interest Per $1,000 of Loan Per Month |
|---|---|
| 0.25% | $0.21 |
| 0.50% | $0.41 |
| 0.75% | $0.62 |
| 1.00% | $0.82 |
| 1.25% | $1.03 |
| 1.50% | $1.23 |
| 1.75% | $1.44 |
| 2.00% | $1.65 |
| 2.25% | $1.85 |
| 2.50% | $2.06 |
| 2.75% | $2.26 |
| 3.00% | $2.47 |
| 3.25% | $2.67 |
| 3.50% | $2.88 |
| 3.75% | $3.09 |
| 4.00% | $3.29 |
| 4.25% | $3.50 |
| 4.50% | $3.71 |
| 4.75% | $3.91 |
| 5.00% | $4.12 |
| 5.25% | $4.32 |
| 5.50% | $4.53 |
| 5.75% | $4.74 |
| 6.00% | $4.94 |
| 6.25% | $5.15 |
| 6.50% | $5.36 |
| 6.75% | $5.56 |
| 7.00% | $5.77 |
| 7.25% | $5.98 |
| 7.50% | $6.18 |
| 7.75% | $6.39 |
| 8.00% | $6.60 |
| 8.25% | $6.80 |
| 8.50% | $7.01 |
| 8.75% | $7.22 |
| 9.00% | $7.42 |
| 9.25% | $7.63 |
| 9.50% | $7.84 |
| 9.75% | $8.04 |
| 10.00% | $8.25 |
As you can see, the interest rate can increase the amount of your payment significantly. If you want to see how much interest you are paying to consolidate your debt simply take find your interest rate in the left column. Then find the number to the right of it (the number to the right of 10% is $8.25). Now take this number and multiply it by the amount of your loan and this will be the amount of interest that you pay in a month for that amount.
Example: a $25,000 military debt consolidation loan at a 6.25% interest rate
You would take the $5.15 (from the chart above) and multiply it by 25 ($25,000/$1,000). This equals $128.75.
To sum up, the higher the interest rate on your loan the more money you are going to have pay each month and the less likely that your attempt at consolidation will have the positive effect on your cash flow that you had hoped for. That is why getting a low interest debt consolidation loan is such an important step if you go this route.
Understanding The Term of Your Loan
The next big item on the list that debt consolidation beginners must grapple with is the term, or duration, of their loan. How long it takes to pay off your loan will directly impact the amount of money that you pay your consolidation company. A shorter term will mean a higher monthly payment but will also mean that you spend less time paying off the loan and pay less over the long term.
Here is a chart examining the effect of loan term using the military debt consolidation loan from the example above - a $25,000 loan with a 6.25% interest rate:
| Term (Years) | Monthly Payment | Total Paid |
|---|---|---|
| 1 | -$2,154.53 | -$25,854.41 |
| 2 | -$1,110.83 | -$26,660.01 |
| 3 | -$763.38 | -$27,481.81 |
| 4 | -$590.00 | -$28,319.78 |
| 5 | -$486.23 | -$29,173.89 |
| 6 | -$417.28 | -$30,044.08 |
| 7 | -$368.22 | -$30,930.27 |
| 8 | -$331.59 | -$31,832.39 |
| 9 | -$303.24 | -$32,750.34 |
| 10 | -$280.70 | -$33,684.03 |
As you can see, as the number of years in the loan's term increases the monthly payment decreases. You will also notice that the longer the term of the loan the more you end up paying out to your consolidation company.
The term of your debt consolidation loan is going to be very important in determining how much you pay and whether or not the loan will help or hurt you in the cash flow department. Be sure to be aware of how the term of will impact you in your given situation before you sign any agreement.
Loan Fees Matter Too
Last on the list of things that you must know and take into consideration before getting talked into a deal is the impact that loan fees are going to have on you. Here are a list of questions that are good to ask your loan officer:
- Are there any upfront fees for this loan?
- Are there any prepayment fees? A prepayment fee can be charged to borrowers who pay a loan off before the end of the loan's term. Prepayment fees can be very bad for borrowers since they usually make it so you have to pay the maximum amount of interest to your lender.
- What are the fees that I could potentially be charged and under what circumstances would I be charged them?
You should not feel stupid for asking so many questions! Your financial life is at stake here and you have a right as a consumer to be well informed about how debt consolidation loans will affect your finances.
A fee of $10 on a $1,000 loan with a term of 1 year is the same as adding 1% to the interest rate! Fees can add up fast so be very careful about getting a low interest rate, high fee loan - they can come back and bite you in the butt.
Information and Questions Are Key
Making sure that you ask a lot of questions is the best way to get information on debt consolidation loans. After that is some basic math knowledge (or finding tools like this site provides) so that you can analyze the information that you gathered in asking so many questions! Your debt consolidation loan should not be taken lightly and you should view it as a serious and somewhat risky step in reducing an overbearing debt load so getting all your options out on the table for you to think about is really, really important.
If you are a beginner than you simply cannot do without this debt consolidation information.
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