Should I consolidate loans and cards, or just cards, leaving multiple loans?

Question

I will start off by saying that I suck with credit cards. I just can't manage them, and if I have access to them, I end up impulse spending money. I should not need to; I earn great money, but I seem to be really good at compartmentalizing things and creating this false economy with cards where I think I am doing okay, but really just getting worse.

I have about $22,000 in credit card debt with rates from 12%-19%. I have an $18,000 personal loan at a rate of 12.99% with 2.5 years left on it. Thanks to some recent events, I pretty much have no savings now.

I want get rid of my cards. I want that debt to be "non-reusable" debt. I am confident that with no debt, I would never need cards again. I have had debt as long as I have been working; I am 31 now, and I want it gone.

I am looking at getting a personal loan for total debt + $3,000 at %13.89 over 4 years, with the target to end in 3 years.

The extra $3k is to put into savings so I can start my new budget with a cash buffer.

Questions:

1. Is the cash buffer from the loan a bad idea?
2. Should I consolidate just the cards, and have two loans to pay off?

If it makes any difference, I estimate I can pay between $1,200 and $2,000 a month of this debt while still saving $500 a month and living comfortably. Any holidays would have to come out of that $500 a month.

Answer 1

First of all, congratulations on admitting your problem and on your determination to be debt-free. Recognizing your mistakes is a huge first step, and getting rid of your debt is a very worthwhile goal.

When considering debt consolidation, there are really only two reasons to do so:

Reason #1: To lower your monthly payment. If you are having trouble coming up with enough money to meet your monthly obligations, debt consolidation can lower your monthly payment by extending the time frame of the debt. The problem with this one is that it doesn't help you get out of debt faster. It actually makes it longer before you are out of debt and will increase the total amount of interest that you will pay to the banks before you are done. So I would not recommend debt consolidation for this reason unless you are truly struggling with your cashflow because your minimum monthly payments are too high. In your situation, it does not sound like you need to consolidate for this reason.

Reason #2: To lower your interest rate. If your debt is at a very high rate, debt consolidation can lower your interest rate, which can reduce the time it will take to eliminate your debt.

The consolidation loan you are considering is at a high interest rate on its own: 13.89%. Now, it is true that some of your debt is higher than that, but it looks like the majority of your debt is less than that rate. It doesn't sound to me that you will save a significant amount of money by consolidating in this loan. If you can obtain a better consolidation loan in the future, it might be worth considering.

From your question, it looks like your reasoning for the consolidation loan is to close the credit card accounts as quickly as possible. I agree that you need to quit using the cards, but this can also be accomplished by destroying the cards. The consolidation loan is not needed for this.

You also mentioned that you are considering adding $3,000 to your debt. I have to say that it doesn't make sense at all to me to add to your debt (especially at 13.89%) when your goal is to eliminate your debt. To answer your question explicitly, yes, the "cash buffer" from the loan is a very bad idea.

Here is what I recommend: (This is based on this answer, but customized for you.)

1. Cut up/destroy your credit cards. Today. You've already recognized that they are a problem for you. Cash, checks, and debit cards are what you need to use from now on.

2. Start working from a monthly budget, assigning a job for every dollar that you have. This will allow you to decide what to spend your money on, rather than arriving at the end of the month with no idea where your money was lost. Budgeting software can make this task easier. (See this question for more information.

3. Your first goal should be to put a small amount of money in a savings account, perhaps $1000 - $1500 total. This is the start of your emergency fund. This money will ensure that if something unexpected and urgent comes up, you won't be so cash poor that you need to borrow money again. Note: this money should only be touched in an actual emergency, and if spent, should be replenished as soon as possible. At the rate you are talking about, it should take you less than a month to do this.

4. After you've got your small emergency fund in place, attack the debt as quickly and aggressively as possible. The order that you pay off your debts is not significant. (The optimal method is up for debate.) At the rate you suggested ($2,000 - 2,500 per month), you can be completely debt free in maybe 18 months.

5. As you pay off those credit cards, completely close the accounts. Ignore the conventional wisdom that tells you to leave the unused credit card accounts open to try to preserve a few points on your credit score. Just close them.

6. After you are completely debt free, take the money that you were throwing at your debt, and use it to build up your emergency fund until it is 3-6 months' worth of your expenses. That way, you'll be able to handle a small crisis without borrowing anything.

If you need more help/motivation on becoming debt free and budgeting, I recommend the book The Total Money Makeover by Dave Ramsey.

Answer 2

My answer is similar to Ben Miller's, but let me make some slightly different points:

There is one excellent reason to get a consolidation loan: You can often get a lower interest rate. If you are presently paying 19% on a credit card and you can roll that into a personal loan at 13.89%, you'll be saving over 5%, which can add up.

I would definitely not consolidate a loan at 12.99% into a loan at 13.89%. Then you're just adding 1% to your interest rate. What's the benefit in this?

Another good reasons for a consolidation loan is psychological. A consolidation loan with fixed payments forces you to pay that amount every month. You say you have trouble with credit cards. It's very easy to say to yourself, "Oh, just this month I'm going to pay just the minimum so I can use my cash for this other Very Important Thing that I need to buy." And then next month you find something else that you just absolutely have to buy. And again the next month, and the next, and your determination to seriously pay down your debt keeps getting pushed off. If you have a fixed monthly payment, you can't. You're committed.

Also, if you have many credit cards, juggling payments on all of them can get complex and confusing. It's easy to lose track of how much you owe and to budget for payments. At worst, when there are many bills to pay you may forget one. (Personally I now have 3 bank cards, an airline card, and 2 store cards, and managing them is getting out of hand. I have good reasons for having so many cards: the airline card and the store cards give me special discounts. But it's confusing to keep track of.)

As to adding $3,000 to the consolidation loan: Very, very bad idea. You are basically saying, "I have to start seriously paying down my debt ... tomorrow. Today I need a some extra cash so I'm going to borrow just a little bit more, but I'm going to get started paying it off next month." This is a trap, and the sort of trap that leads people into spiraling debt. Start paying off debt NOW, not at some vague time in the future that never seems to come.