Debt Consolidation As A Cash Flow Solution
When debt payments make up an extraordinarily high percentage of your income a person can feel overwhelmed and out of balance. Their financial health is at serious risk because simple increases in the cost of living (such as the high gas prices that swept the US a few short months ago) can increase the pain felt by individuals and families at an alarming rate. Even worse, the could be forced to take on even more debt to survive which can have crippling effects on their financial future.
In my previous post about debt consolidation loans for beginners I introduced a fictitious character named John who found himself in $47,000 worth of consumer debt. He bought a nice car, went on nice vacations, and financed a lifestyle moderately outside his means. For the sake of this example, let's say that his $10,000 credit card debt is divided as follows:
- $6,000 on an American Express card at 9% interest
- $4,000 on a Mastercard at 11% interest
(Note: At his current payment levels - i.e. the minimum on his credit card - it will take John 44 months to pay off his AmEx card and 29 months to pay off his Mastercard.)
To really see this example in the light of a cash flow problem we are going to need to take a look at how much John earns each month. John works at a medium sized paper company in the American north east as a salesman. His annual earnings are $40,000 a year which comes to about $2,200 a month when taxes and benefits are deducted from his paycheck.
Now let's add up all John's expenses and see where his cash flow ends up when we just take into consideration his necessities:
| $ 2,200.00 | Income |
| $ (1,000.00) | Debt |
| $ (650.00) | Rent |
| $ (150.00) | Gas |
| $ (250.00) | Food |
| $ 150.00 | Total Cash Left |
Once John covers all of his necessary obligation his he still has $350 left. Every last penny of this he spends entertaining his girlfriend and himself with movies, weekend trips, and various fun young people activities.
But what happens when his cost of living increases? If a roommate moves out, or gas prices double again, or food costs increase by 10%, or all of these happen at once and John is in serious debt trouble. He will be forced to take on new debt to provide for the necessities of life.
In this case, a debt consolidation loan could reduce John's payment.
Maybe he finds a good, reputable debt consolidation company that is going to offer him a reasonable interest rate of 6% for the entire balance of his outstanding consumer debt with a 10 year term. Now he makes one payment to one company instead of making 3 payments to three different companies. He also has slashed his monthly payment in half - reducing in from approximately $1,000 a month to $521.80 a month. His new cash flow looks like this:
| $ 2,200.00 | Income |
| $ (520.00) | Debt |
| $ (650.00) | Rent |
| $ (150.00) | Gas |
| $ (250.00) | Food |
| $ 630.00 | Total Cash Left |
Having $630 left a month is a lot more wiggle room for increased costs than $150 is. Again, the one major benefit for debt consolidation loans is that they can increase your monthly cash flow so that you can better meet your current financial obligations without taking on any more debt. However, this cash flow fix does come with a price.
Debt Consolidation Loans Increase Your Costs Long Term
The price is in increased over the long term because the term of the loan in increased while the interest rate is decreased. Before the consolidation John would have paid $54,200 to pay off his $47,000 in debt. Under the new loan that consolidates his debt he will end up paying $62,600 - a full $8,000 more than he would have been paying before the consolidation.
This is a fact that is simply undeniable and if you are interested in thinking of pursuing this reduction strategy you will definitely need to take this into consideration. Ask yourself the question: Is it better to pay less now but more over the long run, or are there some real ways that I can cut my current costs to get this debt out of the way and out of my life?
Now there is a chance that you can consolidate the debt and actually decrease the amount that you will repay over the lifetime of your loan, but these cases are extremely rare and not very likely. You are going to need a solid debt consolidation plan if you are going to be able to take advantage of these offers so make sure you know what you are getting yourself into.
Be wary of companies offer rates that look too good to be true - they may engage in tactics that end up hurting you in the long run like negotiating your debt with your creditors. This will hurt your credit score and could make it harder for you in the future when you attempt to buy a house as your interest rates could be higher as a result.
Another thing to look out for in companies that offer rates that seem too good to be true is for hidden fees that effectively increase your loans rate but get tacked on at the beginning or end of the loan. A $100 fee on the $47,000 loan represents adds .2% to the interest rate on the loan. So $1500 in fees and closing costs will effectively turn a 3% interest rate into a 6% interest rate. Be careful and read your loan documents to make sure that you only use loans that help you rather than hinder you.
When it comes down to it, make sure that you know what you are getting into before making any debt consolidation loans. Know the terms of the loan and any fees that may come. Understand how your overall costs are going to increase and how the loan will positively affect your cash flow. Be informed and debt consolidation loans because in the end you alone are responsible for you financial health.
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