When it Makes Sense to Consolidate

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My roommate is in a similar position to me, but without quite as much credit card debt. He is faced with about $3,000 in credit card debt, and about $14,000 left on a car note. He looked at his situation, and is really not able to put more money each month toward the credit card debt. He has enough for minimums plus maybe a little bit extra. His credit cards are around 22-24% APR, and his car note is around 7-7.5%. He has four years left on his car, and by paying minimums about a century left to pay the credit card debt off.

He has been looking into consolidation lately, and visited Wells Fargo, who denied him a consolidation loan for the credit card debt. They said to come back and refinance the car along with it, and they could probably do something. So after estimating that a 4-year refinanced note for $19,000 (to pay off cards, car, and establish an emergency fund to keep from using cards again) at 10% would be about the same monthly payment he’s already making now. While he’s taking a bit of a hit on the car portion, it enables him to eliminate all credit card debt faster than he can pying minimums. I agreed it might be good to look into, so he went to Wells Fargo again.

It didn’t go well, to make a long story short. The best they could offer is $19,000 at 22% interest for 5-6 years. Obviously he could see it made no sense at all to do this and left right away. However, when I had a chance to use some calculators, I’m actually glad they didn’t give him the deal I’d estimated. Just goes to show your head can be a bit tricky, and you should always verify a scenario using actual math.

Adding the numbers for long term cost, he will have paid $8,000 or so on those credit cards, and about $16,000 on the car, for a total of $24,000. Even if he got the consolidation at 10%, he’d still be paying about $23,500 towards his total debt. In this situation, it might not make sense at all to consolidate. Since the primary portion of his debt is lower interest, it would be better for him to keep finding other ways to pay off the credit card debt sooner. I am going to advise him to try to get his interest rates lowered (he has made good payments for awhile, so that will help his standing). Luckily, in just a month his FICO score improved about 30 points, so that can’t hurt either. I will also advise him to try to pay even $25 per month extra on his cards. If he can even pay just $25 extra per month, he’ll have it paid off in 3 years. If he can pay an extra $55/month, it would shorten it to right over 2 years, and he’ll only pay a total of around $4,200, which is a much better deal than if he were able to consolidate.

I learned a few lessons from this, which I hope will keep me from making the mistake of consolidating when it doesn’t make sense.

1. Never consolidate upwards. The fact that $14,000 at ~7.5% would be moved upwards at all is a pretty good indicator it would never work. You almost always lose money this way. While adding the car enabled him to get a loan at all, even at a low interest rate of 10%, it does not make sense. I imagine raising the rate only works when the low interest debt is a tenth or so of your total debt, or at least less than a quarter.

2. Credit Unions aren’t always the best deal. I find it absurd they didn’t see the opportunity to make interest they would not have been able to make otherwise. The minimums would have stayed the same and his credit score is improving, so there is little risk in defaulting. It would have been an easy $6,000 income for Wells Fargo. While local credit unions usually have a good reputation for really looking at the customer’s needs, it was clear the guy didn’t even have a clue here. I’m pretty sure that’s turned me off of Wells Fargo, if they can’t even understand math any high schooler could do. Granted, if the person is in financial trouble, they may be willing to sacrifice and get a higher rate for a longer term (I imagine most refinance deals are like this), but my roommate was clear that he simply wanted to be able to pay off his debt earlier. It was obvious he got some sort of standard treatment instead of someone paying attention to his debt and giving him a workable solution.

3. The raw power of extra payments. Even $15 extra per month cuts the total credit card payment term in half or more. It is clear that to pay off any debt, you should first try to put extra money into it, then try to get the rates lowered. Only when you find lower interest rates should you move money around. But anyone can come up with an extra $25 per month and be out of debt in three years, and most can find $55 for only two years. Even if you sacrifice something little, it’s totally worth that extra bit. Even $10 extra per month takes years off your repayment schedule.

So, while it’s disappointing he won’t get the easy way out (we single guys love the thought of only having to pay a single bill towards debt), at least there is a more workable solution than the credit union could offer. While it’s certainly not always fun to lower your standard of living to make extra payments to debt (it’s more fun to buy than pay for things you bought a long time ago), it certainly makes mathematical sense. Here’s hoping he can squeeze in some extra payments, and perhaps his creditors will give him a little break on his rates.

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