The problem with credit cards is that they can either be helpful little tools or can morphinto nasty creatures – depending on how they are used. A second problem with credit cards is that they make it incredibly easy for people to get seriously in debt as they are so easy to use. When a person sees something that he or she would like to buy but doesn’t have the cash available, no problem. Just whip out a credit card and charge it. Of course, as the old saying goes people who want to dance have to pay the band. And people who keep charging items will eventually have to pay the band in the form of big debt problems.
The answer to why to consolidate credit card debt is simple. It’s a way to get the credit card companies or debt collectors off one’s back and to also save money in the process. While it may seem counterintuitive to borrow money to pay off debts, the fact is that a debt consolidation loan can do just this.
Here’s an example of how this can work. A person who has credit card debts with APR’s of 18% or higher could transfer the balances on those cards to a new one with a much lower interest rate. For example, the person could get a “no-frills” credit card with an interest rate as low as 8%. Let’s suppose that the person owed $20,000 on five credit cards that had an average interest rate of 18%. If that person wanted to clear that debt in three years, it would cost around $700 a month. In comparison, if that debt was transferred to a card with an 8% interest rate, the monthly payment would be approximately $600 a month or a savings of $1200 a year.
A second way to consolidate credit card debt is to get a loan and use the money pay off the credit cards. There are two types of loans available to consolidate debt – secured and unsecured. An unsecured loan is one where there is no collateral required and will probably have an interest rate of12% or maybe 8%. A secured loan can be even better as it should have an interest rate of less than 5%. Why the difference? It’s due to the fact that lenders take more of a risk with an unsecured loan as there is no asset that could be seized in the event that the borrower defaulted on the loan.
People who have a 401(k) or an IRA can consolidate debt by borrowing from him or herself. Most 401(k) plans allow participants to borrow up to $50,000or 50% of what’s in his or her plan, whichever is less. These plans usually allow the borrower to take five years to pay back the money. While interest must be paid on the loan, the borrower is actually paying interest to her or himself, and it will be at a lower rate than a conventional loan. However, it’s important to understand that people who borrow money from a 401(k) and then leave the employer generally will have only 60 days to pay it back. If the money is not paid back within the 60 days, it will be treated as a disbursement and taxed as regular income.
People who have what’s called a whole life insurance policy and have had it for 10 years or longer will have built up cash value and can borrow from it. The borrower can take as long as he or she wishes to pay back the money or not pay it back at all. Of course, any money that is not paid back will be subtracted from the person’s death benefit. For example, if a person were to borrow $10,000 from a policy that had a death benefit of $100,000 and then died. His or her beneficiaries would receive only $90,000.