In my experience as a loan officer for the credit union, one of the most frequent requests was for a debt consolidation loan. Several times a week, I would have a member come to me and explain: “Jason, I can’t seem to catch up. I have too many scattered payments to credit card companies at high interest rates. I can hardly keep up, and I feel like I am getting nowhere. Is there anything the credit union can do to help me?” In most of these cases, the members wanted me to offer the simple solution: a new, unsecured loan to pay off the debt and have one payment with the credit union. Ideally, this is the best solution for everyone involved. The member has one payment, is saving interest, and the credit union has a new loan. It seems perfect, everyone is a winner…right? Surprisingly, in my experience…no. More often than not, members find themselves in a year’s time or less in the same predicament. Why? The answer is equally simple: I can give a member a loan to pay off their credit cards, but I can’t keep them from using them.
If you feel that a debt consolidation loan is your only hope, you first need to identify the source of the problem…your spending habits vs. savings habits. Credit cards and loans were never designed to replace responsible savings. That being said, credit card companies and financial institutions make a lot of money on customers who can’t properly manage their spending. Several of the products and “services” offered by these firms are designed to make the customer’s fail in order to keep the customer in debt longer and receive interest payments.
Debt consolidation is not a product…it is a mission. More accurately, debt elimination over consolidation should be your primary goal. This might sound easier said than done, but the first step is quite simple: stop spending. More specifically, stop purchasing with credit cards and instead rely on cash or debit purchases. If you leave your credit card at home before leaving the house, you will limit your spending power only to the balance you have in your account. This practice yields many positive results. First and foremost, you will not be able to give in to the temptation to make a purchase and “pay for it later.” Additionally, you will be forcing yourself to keep an eye on your spending and account balances. The credit union offers online banking and phone service to make this information easier to access at home or on the go. This small change in habit can have an overwhelming impact in just one month or two.
Now that you have made a move in the right direction, we can address the lingering problem: paying off existing debt. Juggling several credit cards instead of paying them off with a single loan doesn’t make much sense. If you have good credit, why not take advantage of credit union products like a personal loan to pay off the balances? Well…you should; however you must realize that if your habits have not changed, the problem will not go away. In fact, members often secure a personal loan to pay off their debt, only to charge the credit cards right back up. This creates an even bigger problem as the member is heavier in debt, and may have exhausted all of their resources with the credit union in securing the previous loan.
There are several options for consolidating, and ultimately eliminating, debt. For small consolidation loans (under $10,000) a 4 or 5 year personal loan can be the best choice. Qualifying members will find that in most cases, they will save hundreds in finance charges over the life of the loan and have more positive cash flow on a monthly basis. An example of a responsible habit would be to place the money saved on a monthly basis into your savings account. This can be set aside for emergencies or large purchases that you would normally make with a credit card. If you were unable to pay off all of your accounts with the loan, then the most logical use of the savings would be to pay down the remaining high interest accounts. The most common mistake that members make is replacing a portion or all of the monthly savings with new debt. Just because you can breathe a little easier, doesn’t mean you should go out and buy a motorcycle or patio furniture.
In addition to credit cards, some members may have large unsecured debt as a result of student loans or medical expenses. Much like credit cards, these scattered payments are often a large drain on a member’s monthly cash flow. Often times, the balances on these liabilities is greater than the credit union can assume with a personal loan in regards to amount and repayment term. A good strategy for paying off this kind of debt is through equity.
What is equity exactly? Equity is defined simply as the ownership interest in real property. If you have a mortgage or auto loan that you have been paying for several years, chances are you have equity that you can in turn borrow against. Equity is directly related to your net worth, which is simply your total assets minus total liabilities. If you have paid your mortgage for several years or own your home out right, a home equity loan is a perfect choice for restructuring your liabilities. A home equity loan can provide a lower interest rate, longer repayment terms, and possible tax deductions (consult your CPA for specific information.) The best part is that from a net worth position, nothing changes. The amount of debt still exists, but replacing the way you repay it can save thousands in interest with less money paid out on a monthly basis. Equally, if you have an auto that is paid off or almost paid, you may be able to secure a title loan or cash out refinance. If your car is in great shape and you have no immediate plans to sell, why not take advantage of low rates and extend the balance and term by a year? It’s a simple decision if it means paying off a credit card now or in 5 years and with more interest.
These suggestions are based solely on my years of experience helping members on a one on one basis. Keep in mind, no two member’s credit situations are the same. I encourage you to consider some of these options and invite you to contact the credit union for more information. If you have success with any of the topics discussed today, please share your story with us. Helping our members by providing the tools for financial success is among our founding principles.