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When you get your debts consolidated you could feel an incredible sense of relief. Just think. No more from calls from angry lenders and no more stress trying to juggle a bunch of different credit card bills with different minimum payments and different due dates.
But there's a danger here if you start feeling invincible. It's a trap to think that everything's okay and you can start using your credit cards again because they now have zero balances. But then, before you know it, you're in the same position as you were before.
The way to avoid this trap is to keep reminding yourself that you really aren’t out of debt – that you still have a lot of debt outstanding. You might close some of those credit cards, cut them up or put them in a block of ice. Hang on to a couple of them that have low credit limits and use them only in the case of an emergency.
You fail to develop an action plan
Even if you've done a really good job of choosing the best possible debt consolidation plan, you're still not off the hook.
You need to make a plan for paying off the debt that you consolidated. This is so that if life throws you a curve – like your car dies or you need to make an unexpected trip to the hospital – you won't turn back to using plastic. Or, worse yet, “frugal fatigue” could set in and you could end up going on a shopping spree to relieve it.
The way to avoid this trap is to meet with your family and maybe a credit counselor or financial planner and make a budget will balance you spending your income and savings goals.
The financial counselor Kathryn Bossler notes that "A budget is such a simple, basic concept, but it’s so powerful. It's the way you learn to live within your means."
One good way to budget is called the envelopes method. It’s where you put a predetermined amount of cash into envelopes labeled groceries, transportation, entertainment, clothing and so on. You should also have an envelope labeled emergency fund so you’re putting money away to cover an automobile repair, a medical bill, a leaky roof and other unexpected costs.
Then when one of these envelopes is empty, that's it. You can't spend any more money in that category.
You can also do this on your smart phone using the free app Mvelopes.
If you're not familiar with this "tough love" form of budgeting, here's an entertaining video that explains it in detail.
But whichever envelope method you choose the important thing is that you'll be putting money aside so that in the future you won't be forced to create more debt.
Frequently Asked Questions about debt consolidation
Q. What does debt consolidation do to your credit?
A. This will depend on the option you choose. However, whenever you apply for new credit it will ding your credit score by a few points. If you've maxed out your credit cards and move those debts into a debt consolidation loan this would increase the amount of credit you have available. Your credit utilization ratio should go down, which would cause your credit score to go up.
Q. How do debt consolidation loans work?
A. You take out a sizable loan and use the money to pay off all your creditors. You then make monthly payments on the loan, which should have a lower interest rate than the average of the interest rates you're currently paying and a lower monthly payment. You may be able to get that loan through a debt relief company, as a personal loan from your bank or as a home equity loan.
Q. Are debt consolidation loans easy to get?
A. This will depend almost entirely on your credit score. If you have excellent credit (a credit score of 781 or above) it will be easy to get a debt consolidation loan. If your credit score is 661 to 780 it should be fairly easy for you to get one. However, if your credit score is below 601 you may find it difficult.
Q. What debts can be rolled into a debt consolidation loan?
A. In theory almost any debt can be rolled into a debt consolidation loan. However, as you have read in this article the best debts to consolidate are those that have high interest rates. These are generally credit card debts, personal loans, personal lines of credit, payday loans – and other such unsecured loans.
Q. When is debt consolidation a good idea?
A. It can be a good idea if you have multiple, high interest debts. It's become popular because it offers some important benefits. For one thing, it's just a lot easier to make one payment a month that a lot of different payments with different due dates. But more importantly, the debt consolidation loan should have a much lower monthly payment than the total of the payments you’re currently making.