Should you consolidate before you snowball?
A debt consolidation loan pays off several debts at once and leaves you with one loan and one payment. It can save real money, or it can cost more than it looks like it saves. The only way to know is to compare the loan against the plan you'd follow anyway, with the fee counted. That's what the box below does.
Would a consolidation loan beat your plan?
Using our example plan (four debts, $200.00 a month extra). Build your own plan and this box will use yours.
This loan would save $167.60 in interest and fees, and you'd be debt-free in the same month.
A loan like this beats your plan only if its APR is under 15.4%, fees included.
Loan of $4,620.00 (fee $220.00 included), required payment $153.46 a month. You keep paying $635.00 a month in total, as now.
What decides whether it helps
Two numbers matter: the loan's APR and its fee. The origination fee is usually 1% to 10% of the loan, often added to the amount you borrow, so you pay interest on it too. A loan helps only when its rate is far enough below your current rates to cover that fee.
In our example, the store card ($600.00 at 24.99%) and Visa ($3,800.00 at 21.99%) move into a 12% loan with a 5% fee. The fee is $220.00, and the loan still saves $167.60 overall. The break-even rate is 15.4%: any offer above that costs more than simply snowballing the cards.
Keep paying what you pay now
Loan offers often advertise a lower monthly payment. That comes from a longer term, not from saving money. If you drop your payment to the new, lower amount, you'll be in debt longer and usually pay more interest in total, even at a lower rate. The box above assumes you keep paying the same total each month and put anything the loan doesn't need toward your next debt, snowball style.
Where the loan fits in the snowball
The loan becomes one more debt on your list. With the snowball it takes its place by balance, and it's usually the biggest debt, so your freed-up payments reach it last. That's fine: the smaller debts still give you quick wins, and the loan's lower rate works in the background.
The risks
- Running the cards back up. This is the big one. Consolidating leaves the cards at zero, and new spending on them puts you further behind than before. Many people put the cards away, or close the newest ones.
- Secured loans. A home equity loan or line of credit may have a low rate, but it turns card debt into debt secured by your house. Missing payments can cost you the home.
- Your credit. Applying causes a hard inquiry, and the rate you're quoted depends on your credit. Advertised “as low as” rates go to the strongest applicants, so run the box with the rate you're actually offered.
When a loan isn't the answer
If your payments can't keep up with the interest now, a new loan usually just moves the problem. A nonprofit credit counseling agency can review your budget for free and may offer a debt management plan that lowers your card rates without a new loan. Look for one accredited by the NFCC or FCAA.
Considering a 0% card instead? Read balance transfer cards and the debt snowball.
Run your own numbers
The box above uses your saved plan once you have one. Build your plan in about a minute, then come back and try the loan offers you've actually been quoted.