How to Compare Your Current Monthly Debt to a New Consolidation Loan

If you want to decide if you should consolidate all your debt, such as credit cards, installment loans or car payments, into one combined monthly payment, your decision should be based on a few factors. Many times a debt consolidation using your home as collateral is a wise thing to do, and sometimes is can be a mistake. Or maybe you are considering taking on a loan using something else for collateral, such as a vehicle title, or possibly no collateral being used at all. In any event, you want to determine if this consolidation will help you or possibly cost you more in interest in the long run, even though you are receiving a lower interest rate on the new loan. By performing a simple analysis you will become more informed of the facts and should feel better about your decision.

Difficulty: Moderately Easy

Instructions

Things You'll Need:

• List of all the debt you are considering to consolidate and what the interest rates are
• Calculator
• Ledger paper

1. Create a column for the name of the company you owe, the total amount you owe, the minimum monthly payment, or the usual payment you make, and the interest rate.

2. Add up the grand total of your debt and the total monthly payments you are making.

3. Add up all of the interest rates you pay. Put them all into your calculator and then divide that total amount by the number or interest rates. This will provide and "average" rate of interest you are paying. This is a simple method and is only meant to provide an "average," for concept sake. For instance, if your largest debt is based on a low interest rate and other small debts based on high rates, it may not be a fair average. Keep this in mind and calculate accordingly. Your goal is to come up with a fair average of your current interest rates.

4. Determine the number of years it will take you, again on average, to pay off all of your debt based on your normal monthly payments. Take the total amount of debt you owe and dived it by the total "yearly" payments you are making. You may want to eliminate debts from this calculation that will be paid off very soon.

5. Now look at your new consolidation loan proposal. What will your new monthly payment will be, the rate of interest and length of time, or the term? The term is a very important factor to consider.

6. We need to determine how much interest you will be paying on your current debt as compared to a new consolidation loan. Here is an example. Use $25,000 as the total current debt based on 10.000 average interest rate using a five-year repayment term. The monthly payment is $531.18 and the monthly interest portion of this payment is $208 for a total amount of interest paid in of $12,480, which is the $208 per month times 60 months. To determine the interest portion of the payment use the loan amount multiplied by the interest rate divided by 12.

7. Now take the same $25,000 based on a 30-year term at 7.000 interest. This monthly payment is $166.33 and $145 per month of it is the interest portion, for a total of $52,200 paid in interest. This is the $145 per month multiplied by 360 months.

8. Keep in mind that as you reduce your principal balance each month the amount paid towards interest will also reduce in both scenarios, but the plan with the shorter term will decrease much quicker. We would need a full-term amortization chart to get exact figures, so please consider the "actual" amount of interest paid in to be a fictitious figure, but should serve as an example to see the general difference for proportion sake.

9. See the difference here, even though the interest rate is only 7.000 for the new loan compared to the 10.000 on the current debt, because the loan is on a much longer term, 30 years instead of five, it will cost you $39,720 additional in interest. This is the difference between the $52,200 and $12,480 mentioned above.

10. Look at the $323 per month savings now, ($531. payment for the five-year term versing the $208. payment for the 30-year term), you will have in your pocket if you do stretch your debt over to a 30-year term. Can you invest that money and gain back more of a return than the cost of the additional interest you would pay over a 30-year term?

11. Also consider the cost, if any, in obtaining your new consolidation loan, such as closing costs, appraisal or broker fees. If you turn your original $25,000 debt balance into $27,000, how much more will this cost you?

Tips & Warnings

• Always consider the term of the new loan, regardless of the possible lower interest rate. How much more will you be paying in the long run, and if you do stretch your debt out, will you be putting the monthly savings to work for you?

[MidniteWriter]

on 12/26/2007 be careful not to take on too much debt and get more besides the consolidation. Good tips!