How To Use A Credit Card As A Debt Consolidation Loan

My last post about how to avoid debt consolidation loans got me thinking about using credit cards as a way to reduce the number of creditors you are paying as well as reduce the amount of interest you pay out each month. This is a viable strategy that a lot of people use even if they aren't in a lot of debt. It has several different names that it commonly goes by on the internet and among financial professionals, like credit arbitrage and balance transfers, but the principal is the same: reduce debt interest rates by moving your money around to a new debt holder.

The Holy Grail of credit cards are the 0% balance transfers that were about as common as grass a couple of years ago. I'm not sure if they are as prolific now as they were then (I removed my name from some list to stop the flood of credit card offers I was receiving in the mail), but if you can get one they can really help you reduce the amount of money that you owe to your creditors by making more of your interest payments go to your debt principle.

As always let's take a look at an example. Right now I have an outstanding balance on my Chase Freedom Rewards Credit Card of $417.23. I never carry a balance month to month, but if I did my monthly minimum payment would only be $10. Right now my interest rate on this card is 13.24% APR. If I were to only make the minimum payment of $10 a month it would take me a total of 56 months to pay off the card.

If I were to transfer the balance of this card via a 0% APR balance transfer I would be able to pay off the card in 42 payments. That is a difference of over a year!

Now this example is not very realistic - who would only pay a $10 minimum payment on a debt of $400? Most people who suffer from lots of consumer debt normally have it spread out over several different debt services and at various interest rates. Can a credit card really be used as a way to reduce this type of debt effectively? What if you can't get a 0% APR balance transfer, is it still worth it?

Consolidating Multiple Sources of Debt On Credit Cards
I do not have too much experience with this one, but I imagine that if you can pay your monthly bill with a credit card then you can "transfer" your debt to your credit card. All you would do to transfer the debt is to charge the entire balance that you owe to your credit car.

This is certainly not without risk. I'm not sure if you are aware of this, but credit card companies can change your rate at any time, for any reason. So let's say that you just got a brand new card from American Express with a balance of $10,000 and an introductory 0% APR for the first 12 months. You decide that paying 0% interest is better than paying 7% interest on your car loan (which it is) so you transfer the $7000 remaining on your car loan to your credit card.

Now if the credit card company doesn't do anything to you you just saved a bunch of money on interest payments if you can pay off the debt by the end of the 12 month introductory rate. You will have saved $270 in interest.

But what if your credit card jacks up your rate to the normal 13% just because they feel like it? You end up paying a lot more interest than if you had just paid off your auto loan normally.

You might want to contact your credit card company to see what their policy would be if you did this to make sure it will fly before you risk that type of cash. Ask questions, get information, and be wise about doing something like this.

Transferring Multiple Credit Cards to Consolidate
This is pretty easy to do and is a lot like the example above, except that it can have less risks if you are aware of the cards "fine print." Most teaser rates are designed to steal credit card customers from other companies, so they have forms that you can fill out to easily and simply transfer balances from one card to the next. If for some reason your new card doesn't have one of these forms then you could always just use the method I stated above, but you will be assuming all the risks.

Knowing your card's "fine print" is incredibly important if you are going to use your credit card as a debt consolidation loan. You have to do it and you have to be certain you know what it is saying. A mistake here can cost you hundreds of dollars.

Balance Transfers To Just Pay Lower Interest
Is it good to simply transfer debt to a lower interest credit card, even if it isn't pegged at 0%? I think the answer to this is yes, but the amount saved depends on the interest rate and the amount of debt that you have. The more debt you have the more a small change in interest rates will save you, but if you only have a $1000 of debt that you will pay off in a year, then the difference between a 4% and 7% interest rate is only going to be about $17.

If the balance is $10000 and the term of the loan is 5 years then the amount saved by going from 7% to 4% will jump to $830, about $166 a year in savings.

The Debt Snowball And Credit Card Consolidation
Probably your best bet at quickly and effectively paying off your debt is to use a debt snowball technique. I am a fan of paying off the highest interest debt first since this will get you out of debt fastest and will have you pay the least amount to your creditors. Here are the main steps of the debt snowball:

1. List all your debts in order of the highest interest rate first and the lowest interest rate last
2. Transfer as much of your high interest rate debt to lower interest rate sources
3. Pay the minimum payment on all your debts and throw as much extra cash as you possibly can at the highest interest rate debt
4. Once that is paid off, take all the money that you were paying on the highest interest rate debt and use it to pay off the next highest interest rate debt
5. Continue this process until all your debt is completely gone

This method is proven to pay off debt quickly and efficiently and all major financial experts that I know of recommend a version of the debt snowball method.

So credit cards can be an effective way of creating your own debt consolidation loan and can help expedite your journey toward debt freedom if used wisely and according to your card issuer's terms and conditions.

5 Ways To Avoid Debt Consolidation Loans

Debt consolidation is not your only option when faced with a mountain of debt. If fact, getting a consolidation loan can be a bad option for you and your family if you do not really need to get one. There is no sense on taking on more debt* to pay off your debt. Here are five simple (but not easy) ways for you to reduce the amount of money you pay your creditors while speeding up the time it takes you to pay off all your debts.

* For a more in depth discussion of how you actaully pay more with debt consolidation loans even though your monthly payment is less see my article on whether or nor debt consolidation loans are good for the long term.

Earn More Money
If you have a lot of debt then it is obviously the case that you do not earn enough money to handle your current lifestyle or that some unexpected emergency has come upon you, destroying your financial health. In some cases, both are true.

One of the remedies for a situation like this is to begin to close the gap between income and expenses by increasing the amount of money that one makes. Charles Dickens has a really interesting quote that sums things up nicely:

Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

Now nobody - not even the British - use this pound system anymore, but that is not the point. The point here is that in one scenario we have a person earning more than they spend which results in a happy state for them. In the other scenario we have a person who has earned less than he spends and the result for him is the misery of indebtedness.*

*This was a misery known firsthand by Mr. Dickens who spent some time inside a debtors prison as a result of his father falling into debt. Dickens had to work in order to get his family out of this prison as a child.

Here are some ideas concerning how you might be able to earn some extra income:

• Get a second job - It doesn't have to be glamorous, it just has to get you extra income and be flexible enough to fit in with your current job. If you don't currently have a job then you need to get one - now!
  
• Ask for more money at your current job - This may be a tough road to hoe in today's job market and economy, but it will not hurt to ask. This is especially true if you are a key player at your work.
  
• Make what money you have work for you - Having all your cash sitting in a non-interest bearing checking account is not going to help you get out debt any quicker. Put some of it in a higher yielding savings account at your bank or one of the many online banks that offer great rates.
  
• Recycle - You can earn hundreds of dollars just by recycling all the cans and plastic bottles that your family uses each month (if you live in a state that does this). But the real money is earned in recycling other people's aluminum cans and plastic bottles. So get creative and save the earth while you get out of debt.
  
• Learn to earn money online - The internet is full of ways to earn an extra buck here and there. Learn some of them and start making your hobby into a full fledged earner for you.
  

Not all of these will work well for everyone, but earning more money is certainly a better option than getting a debt consolidation loan

Spend Less Money
The flip side of the Charles Dickens quote mentioned above is this: if you are spending more than you currently make maybe it is time for you to cut back on your spending. There are literally thousands of ways for you to do this, so I will not and cannot go into intricate detail about this. Instead I will list some of the major ways that you can cut costs in your life:

• Change your eating habits. Spending $6-$10 a meal is not going to get you out of debt anytime soon. That amounts to an astonishing $360 a month just for lunch and dinner for one person! Currently, my wife and I feed two adults for around $160 a month (sometimes more and sometimes less). That works out to be about $0.89 a meal for breakfast, lunch and dinner. I think we eat well and I am extremely active, biking 110 miles a week. You can definitely spend less than $150 per month per person.
• Change your driving habits. Cars are insanely expensive. Having two cars is twice as insanely expensive. If debt is strangling your finances and you want to avoid a debt consolidation loan then one way to go about it is to get rid of one of you cars. You'll have a nice little cash surge from the sale and you won't have all the reoccurring costs of owning a car. I recommend bike commuting, but you can always use public transportation if you live in a climate where year round bike commuting isn't feasible.
• Make sure your housing situation is optimal. If you are a renter - or even a home owner - make sure that your housing arrangement gives you what you need. If you are overpaying because you have more space than you need consider down sizing. If your home is too far away from work or the grocery store then maybe a relocation is in order. Housing can be the largest single expense a family pays so making sure that this is in order can make a huge difference in your ability to pay down debt quickly.
• Stop buying clothes you don't need. You can generally get clothes very cheaply through thrift and second hand stores, close-out sales, or off season shopping. There is no reason why you should every pay full price for a clothing item and there is no reason why you should buy something that is not absolutely necessary. Shopping will never solve your problems while not shopping will solve your debt problem.

There are a host of other things you can do, but if you tackle these four seriously you will be well on your way to getting your income in line with your expenses.

Consolidate Credit Card Debt Onto 0% APY Card
Consolidating via credit card can definitely hurt your credit score (since getting a new card can be impact your score negatively) and it can be difficult to get one of these great deals given today's credit crunch or a history of bad credit, but there is no better solution for this type of debt than this. Getting a 0% APY credit card is a really, really, good idea because you will not be paying any interest on the balance of the card.

Why is this such a good deal? The monthly interest paid on a balance of $1000 and an interest rate of 7% is $5.83. If you have a total credit card debt of $22,000 you will be saving $128.33 a month. But most credit cards have a much higher interest rate - like 13% and up. The amount of interest you will have to pay on a card like that is $238 a month. $238 a month is equal to working ~33 hours at minimum wage (considering that minimum wage is $7.25 per hour effective July 24, 2009). At current minimum wage rates ($6.55) you would have to work 36 hours.

Wouldn't you want 33 hours of your life back? I know I would. Besides, paying 0% in interest sure beats having to get an unsecured debt settlement signature loan and paying up the whazzu in interest.

Sell Underused or Unused Possessions
If you haven't used something in a year or more then it is time to get it out of the house. Sell such items on Ebay or Craiglist and put all the money toward paying off your debts early. It might be hard to part with a beloved shirt or sweater - but avoiding debt consolidation loans is important if you want to save money over the long run. It simply has to be done.

Selling items is also a great way to get rid of things that have reoccurring expenses. Maintaining items - like boats, RVs, and motor bikes - can be extremely expensive and buy getting them out of your hands you put cash in their place end up with less of a drain on your income than before.

Just remember that all the money you earn needs to go to paying down your debt or else you are just going to find yourself in the same exact position you started in: having a lot of crap stuff that you don't even use.

Become Financially Aware
Budgeting. Saving. Investing. All of these words are used by people who have some financial sense. If you are in massive debt then you need to get some financial sense. There are tons of places to do so: the library, the internet, neighbors, churches, and community centers just to name a few. The vast majority of the information is going to be free so it really is up to you to go out there and find it. Get on the internet; go to your library; talk to your pastor; ask a neighbor; get out of debt.

Avoiding a debt consolidation loan is definitely simple if you follow these 5 suggestions, but it may not be easy - especially if you have grown accustom to living a crazy, debt filled life.