By Eric Reich
There’s a lot of talk, ads, etc. around debt consolidation. This comes as no surprise since Americans tend to carry all sorts of debt, including some good but mostly bad. The concept is pretty clear, get rid of higher interest rate debt and replace it with lower rate debt, thereby saving you money. While on the surface it sounds great, debt consolidation isn’t for everyone. This week, let’s discuss what debts we should consider consolidating, and those we should not.
The goal of debt consolidation is to possibly lower your monthly payments and/or the total amount of interest you have to repay. Part of the problem for many consumers is that there are several different ways to go about consolidating debt. These include personal loans, home equity loans or lines of credit, balance transfer options for credit cards, etc. Any of these options can potentially be useful in reducing overall interest payments, but the type of debt you have might help decide which type of consolidation would work best for you. Types of debt that typically get consolidated are credit cards, medical, personal loans, etc.
1. Personal loan. This is typically a fixed term, fixed interest rate loan. The rate tends to be higher than most since there isn’t an asset securing the loan like there is for a mortgage.
2. Home equity loan. A loan against the value of your home which tends to carry a lower interest rate than a personal loan. Be careful when consolidating unsecured debt such as credit cards and turning it into secured debt using your home as collateral. While defaulting on credit card debt will certainly damage your credit, doing so on a mortgage can result in you losing your house in addition to the damage to your credit which is obviously a lot worse.
3. Home equity line of credit. This is similar to a home equity loan but instead of a fixed amount of money borrowed you have access to money up to the limit when you need it. You only pay for the amount you actually use. The interest rate on a line of credit typically varies with current interest rates up to a limit so be mindful when using a line of credit in a rising interest rate environment.
4. Credit card balance transfer. While this may help in the short term, it is really important to pay off the debt before the end of the promotional period. If not, you might end up with higher interest debt than you started with.
5. Retirement plan loans. This allows you to borrow from yourself (and pay yourself back interest). While this option sounds appealing, if you leave your job while you still have a loan balance and don’t repay it timely, the amount of the outstanding loan becomes taxable to you and may even be subject to a penalty if you are not 59 ½.
In general, regardless of the type of loan you take, you need to be mindful of the fees associated with the new loan. Remember that any fees you pay for the new loan takes away from the benefit of consolidating in the first place.
Get advice before deciding to consolidate debt since some debt can be negotiated directly with the creditor. Not all debt should be consolidated which is why advice before the process can be helpful.
Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment advisory services offered through Kestra Advisory Services, LLC (Kestra AS), an affiliate of Kestra IS. Reich Asset Management, LLC is not affiliated with Kestra IS or Kestra AS. The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra Investment Services, LLC or Kestra Advisory Services, LLC. This is for general information only and is not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation. To view form CRS visit https://bit.ly/KF-Disclosures.
Eric is President and founder of Reich Asset Management, LLC. He relies on his 25 years of experience to help clients have an enjoyable retirement. He is a
Certified Financial Planner™ and Certified Investment Management AnalystSM (CIMA®) and has earned his Chartered Life Underwriter® (CLU®) and Chartered Financial Consultant® (ChFC®) designations. A lifelong resident of Cape May County, Eric resides in Seaville, NJ with his wife Chrissy and their sons ,CJ and Cooper, and daughter Riley.
