A client came to me recently because of credit card debt and feeling like she never had anything left over at the end of the month.
I had her do something that I have all my clients with credit card debt do—I had her make a list of all of her credit cards with the balances, the interest rate, and the minimum payment. She had about half a dozen cards with various balances, and a couple of items she had bought on installment.
Over $1K in Minimum Payments
When we added it all up, the total amount was about $25,000, and almost all of it had interest rates of 28% to 29%—that part I expected. But when we added up all of her minimum payments it came out to $1,100 per month. This was a huge chunk of her monthly budget. No wonder she was feeling stressed about finances!
We worked on her budget, finding a way for her to cover her bills, put some money in savings, and start paying down the debt. But I knew it would go a lot faster if we could get those interest rates down. She had a lot of equity in her home so I suggested she get some quotes for a home equity loan. Even though interest rates are high right now, they would still be better than what her credit cards were charging.
Offers Started Pouring In
She filled out an online application and the offers started pouring in—you’ll see why in a minute. One of the offers would have reduced her payments to just $323 per month and it had 12.75% interest—much less than her credit cards. And though there was a $2,500 loan fee, they suggested making the loan for $28,000 to cover it so that she “would get to pocket $25,500 at closing.”
For someone who has been struggling with $1,100 worth of minimum payments every month, $323 can seem like a dream come true. And the interest rate is less than half of what the credit cards were charging, so it’s got to be a good deal, right?
I put the numbers they gave us into an online loan calculator and figured out that with those payments it would take 20 years to pay back the loan, and she would pay $49,536 in interest.
$49K to Pay Off a $25K Debt
Over $49,000 in interest to pay off $25,000 in credit card debt! No wonder she had people knocking her door down to lend her money. And there was also the $2,500 fee they were planning to charge for lending her the money.
Now you know why you see so many ads offering “debt consolidation!” They will definitely “lower your payments”—and they will make a lot of money off of you in the process.
My client also went to her local credit union to get a quote. They offered her a loan for 9% interest with no fee—so the loan amount would just be the original $25,000. If she pays $795 per month it will be paid off in three years, and she will pay only $3,620 in interest while still freeing up about $300 each month for bills and savings compared to her current minimum payments. This would save her a total of about $48,000 compared to the other offer, which she might have taken if we had not done the math.
The Debt Consolidation Trap
One part of the debt consolidation trap is that they lure you in with a low monthly payment. You think, “I can manage that!” It seems like an easy fix and you go for it.
In fact, only looking at the monthly payment to decide if you can afford something is a mistake that many people make, and not just with debt consolidation. It can apply to a car payment, credit card payments, installment payments, or even a mortgage.
You also need to consider:
- the total cost of interest and fees over the term of the loan
- the cumulative effect on your budget of each new monthly payment
- hidden costs that can come with a new purchase (maintenance, insurance, annual fees)
The other big part of the trap is that it does not fix whatever caused the debt in the first place. If you don’t do that it is very likely that you will build up the same debt again and end up in an even worse place. This can be the start of a dangerous spiral down to some very dire consequences, such as bankruptcy, wage garnishment, or home foreclosure.
Make Lasting Change With Financial Coaching
In my financial coaching sessions I will look at your complete financial picture. It is about real fixes and lasting change, and that includes dealing with why you got into debt in the first place, and how to make real changes that will put YOU in control of your money.
Whether you are facing debt, or just want to get better at budgeting and saving money, I have proven strategies that can help. I’m also very good at bringing an objective, numbers-focused perspective to your finances. I can help you make better decisions now and for the future.
My coaching sessions are over video call, and I offer a free 30-minute initial consultation. There is no obligation, this is just to see if my coaching is right for you. If you decide to become my client, I offer affordable coaching packages and I do not sell financial products. Through our one-on-one coaching session I will walk you step-by-step towards a better financial future and real, lasting change.
Schedule a free call with me today!
