Debt consolidation is a very useful tool in every budgeter’s tool belt. It’s a convenient way to rid yourself of your debts quickly by combining all your current outstanding loans and liabilities (and their generally outrageous interest rates) into a single debt vehicle with a lower interest rate.

It lightens the debt interest load by taking all the outstanding debts and payments and transfers them all into one loan, with only one payment date to remember, and one statement to read.

Instead of having to pay a number of different lenders each pay period, you take out a new loan to pay off all of the other liabilities and are left with only one, lower interest loan to service, allowing you to pay down your debt more quickly.

How It Works
Taking on debt to get rid of debt? How can this possibly help? Let’s look at an example.

Let’s say that you currently have three credit cards that charge 28% interest annually, they are maxed out at $5,000 each and you’re spending $250 a month on each card to pay them off. If you were to pay off each credit card separately, you would be spending $750/month for 28 months and you would end up paying a total of $5,441.73 in interest.

However, if you transfer the balances of those three cards into one consolidated loan at a more reasonable 12% interest rate and you continue to repay the loan with the same $750 a month, you’ll pay one-third of the interest ($1,820.22), and you will be able to pay off your loan five months earlier. This amounts to a total savings of $7,371.52 ($3,750 for payments and $3,621.52 in interest).

Loan Details	Credit Cards (3)	Consolidation Loan
Interest %	28%	12%
Payments	$750	$750
Term	28 months	23 months
Bills Paid/Month	3	1
Principal	$15,000 ($5,000 * 3)	$15,000
Interest	$5,441.7($1,813.91*3)	$1,820.22
Total	$20,441.74	$16,820.22

Remember, consolidation only works if you don’t pick up those three credit cards at the end of the day and start spending again. It’s a tool to help you get out of the doghouse, not to get you a nicer and more expensive doghouse.

If you answer “yes” to any of the following questions, you could probably benefit from consolidation.

1. Do you find yourself using your credit card or line of credit to meet basic expenses month after month?
2. Do you write checks for amounts greater than your account balance because you expect to make a deposit to cover them later?
3. Do you buy items with your credit cards that you wouldn’t buy if you had to pay with cash?
4. Do you open new credit card accounts when your existing accounts are at their limits?
5. Do you borrow money from coworkers, friends and family – or anyone who’s willing to lend it?
6. Do you sometimes worry that you won’t have enough money to pay your bills?
7. Do you lie about what you bought or how much you spent on an item?
8. Have you ever taken cash advances on one card to pay the minimum balance on another?
9. Do you continually go over your spending limit or use your credit cards as a necessity rather than a convenience?
10. Have you been called by a collection agency?

5 Steps to Easy Consolidation

Step 1: Identify your debt load
This is where you’ll be identifying “good debt” from “bad debt.” For example, mortgage debt that is less than 25% of your gross income is considered good debt, whereas consumer debt is bad debt.

Next, calculate total debt owed to family and creditors, identify which debt has the highest interest rates and find out how much you are actually paying in interest on those debts.

As shown in the above example, three credit cards maxed out at $5,000 and paid off over two years actually cost $20,441.73 to pay off – significantly more than the $15,000 owed. So find out what you’re actually spending your money on and determine how much you need to pay it all off.

Use Gail Vaz-Oxlade’s very helpful online tool to help you determine how long it will take to pay off specific debts over the course of one/two/three years.

Step 2: Create your budget
Decide how much you actually need for daily life, fun, savings and to service your debt repayments. You’ll find out that you’ll have to cut out some of the luxury items in your budget until you get your debt in order.

Use Gail’s other handy online tool for building a budget that works.

Step 3: Get your consolidation loan

• How to Apply: Call and book an appointment with a financial advisor at your bank of choice. Often, you’ll get the best rates with the bank you have the most history with, or the one that holds your mortgage.
• Documents: Although each lender will probably require different documentation depending on your history, the most commonly required pieces of information include a letter of employment, two months’ worth of statements for each credit card or loan you wish to pay off, and letters from creditors or repayment agencies.
• Equity vs. Debt: According to Gail Vaz-Oxlade (this article’s main authority), “if you have equity, you should refinance. “This means that you take your unsecured debt (credit cards or personal loans) and put that debt into a secured debt structure (eg. mortgage). Banks will often charge you less interest on a secured debt because if you default, the bank can get its money back (through the sale of your home or other assets).
• Term: Aim to pay off your consolidation loan in three years to avoid ‘debt fatigue.’

Step 4: Pay off your debt
Start by paying off your highest-interest debt first. If you have a lower-interest loan that is causing you more emotional and mental stress than the higher interest ones (like a personal loan that has stretched family relations), you may want to start with that one instead.

Step 5: Stick to the plan!
Consolidation only works to free you from debt if you stop over-spending once you pay off your cards. Once you pay off one set of debts, move the payments to the next set until all of your bills are paid off. Once you are debt-free, you can move those payments into savings or investments.

If You Aren’t Approved for a Loan
If banks or lending institutions laughed you out of the office, or if they won’t reduce their interest payments beyond your current amounts, there are some alternatives to help you get out of debt faster.

• Apply for a lower-interest credit card.  A person who carries a balance every month (and, who is making the required payments) will have a higher credit score than those who pay off their bills at the end of every month. The point here is to get a card with lower interest and transfer the debt from the higher interest cards to the lower interest ones and then close the high-interest accounts.  BUT… You MUST cancel your other cards to prevent you from running them up again. You want to get out of the doghouse, not get a bigger and more expensive one.
• Reduce your debt load and reapply. If you can make the payments on your cards on your own already, try to “up” the amount for a month or two to show the bank that you are dedicated to eliminating your debt. If you have to, get a second, third or better job (temporarily, of course) — to service the debt, not to add to it.

• Dip into retirement savings or insurance plans. This option is less than ideal because you are essentially stealing from your future. However, if all else has failed, you might want to consider taking money out of these areas as long as you make a plan to repay it, and stick to it, in a short time frame.
• Family loans. If you go this route (and as a last resort), write up a contract with your family including payment dates, when the loan will be paid off, and what the consequences will be if payments are missed (added interest, etc).

No Need to Hit Rock Bottom
You don’t need to hit rock bottom before you can start to rebound from debt. Nipping your debt in the bud before you face emotional and financial bankruptcy is the best option, and consolidation is a tool to help you avoid bottoming out. If you can budget and save before you shop and spend, your foundation for a healthy financial life will be set.

by Rachel Humenny — a freelance photojournalist. Her work has been published in newspapers, magazines and on various websites. When not creating stories and articles for both print and online media, she and her husband run a photography company called Diamonds Photography Inc., in Edmonton, Canada.

Gail Vaz-Oxlade is the layman’s financial connoisseur with a rich history of media accolades to prove it.  She has published eleven books on personal finance, a financial magazine for women, hundreds of articles for the financial media, hosted three prime-time television shows and worked with Canada’s leading financial services companies to help educate employees and clients. This doesn’t include her corporate projects and public presentations.  Her website, Debt-Free Forever, offers numerous interactive resources and is a great place to find a gamut of helpful advice.

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