4.6.7 Consolidation loan

You can ask your financial institution about combining or "consolidating" your debts into one loan. The financial institution pays off all your debts and, in return, you make a single monthly payment to the institution. For this new loan to save you money, it must have a lower interest rate than the outstanding loans.

It is important to stop using any credit cards or lines of credit that you consolidated into the new loan, and to stop getting new credit. Destroying all but one of your credit cards will help you stick to the plan.

How debt consolidation works

Here's an example of how debt consolidation might work. Assume that you have the following debts:

• a personal loan of $10,000 at seven percent interest, with an annual fee of $70 and a monthly payment of $300
• a balance of $5,000 on credit card #1, at 19.99 percent interest, with an annual fee of $35 and a monthly payment of $158
• a balance of $2,500 on credit card #2, at 18 percent interest, with a monthly payment of $90
• a car loan of $6,500 at eight percent interest, with a monthly payment of $250.

Now assume that through your consolidation loan you will pay an interest rate of seven percent and make a monthly payment of $800. Here's how your payments would look with and without consolidation: