Debt Consolidation Loan Options

debt consolidation calculator

When exploring loan options to consolidate your debt, it's important to understand the true cost of financing. Many people focus only on one number - the interest rate, which is certainly something to consider, but it also can be misleading, as can the annual percentage rate (APR). When comparing loans for the same term, the APR is a good indication of what is the cheapest, but when comparing loan options with different terms (the length of time it will take to repay a loan), the interest and/or APR may demonstrate to be less representative than looking at the Total Cost (in dollars) of a loan. There can be multiple options available to consumers who are seeking to consolidate debt into a single payment, including Personal Loans, a 401k loan, a Cash-Out Refinance (Mortgage), or perhaps even consolidating into other credit cards. Let's explore examples for each:


Personal Loans: Debt Consolidation Scenario 1
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  • Personal loans are unsecured
  • Personal loans usually offer terms between 3 and 5 years
  • Personal loans usually offer rates between 5% and 36%

Personal loans (also known as signature loans) are unsecured, which simply means there is no collateral behind the loan. For example, with a mortgage the collateral is the property being financed - with an auto loan the car is the collateral. Loans that are unsecured will certainly have higher interest rates than loans that are secured by collateral. See how rates for personal loans are determined for more information.

The interest rate and APR on shorter term loans can be deceiving. We'll summarize all options at the end of this article, but consider the following example:

  • Loan Amount: $15,000
  • Interest Rate: 14%
  • APR: 17.3% (includes a 4.5% origination fee)

This would result in the following:


Based on either a 36 or 60 month loan option in this scenario, the total cost of borrowing $15,000 would be either $4,130.92 or $6,616.43 respectively. Longer term loans for the same loan amount will typically represent a lower monthly payment, but it is always advised to select the shortest term that fits into your monthly budget, and also ensure that the lender does not charge prepayment penalties in the event that you have an opportunity to pay your loan off early.


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Credit Cards: Debt Consolidation Scenario 2
credit cards
  • Leveraging an available balance on a credit card could be an option to consolidate other credit card debt
  • Interest rates on credit cards are variable
  • Balance transfers often have a different rate than regular purchases

If you have multiple credit cards, and a high enough available balance on one to consolidate other debt, you may consider wrapping everything into one bill. That could be an option, depending on the available credit, and interest rate. There are a few things to consider when exploring this option. In the short-term, it is difficult to predict the impact on your credit score. A portion of your score is based on the utilization of your available credit. Meaning, if you have a credit limit on a credit card of $10,000 and an existing balance of $9,000 your utilization is 90%. There are offsetting factors happening when you eliminate a balance from one card, and roll it into another - your utilization on one card may go to zero, but on the card used to consolidate it could approach the full balance (or near 100% utilization). Typically, the higher the utilization, the more impact it could have on your credit score. Unfortunately, the logic to calculate credit scores are proprietary so there's not an easy way to predict the exact impact, but it is likely that your score will decrease if there is a card with a very high utilization rate. Aside from that, let's just consider an example of what this could cost you:

  • Interest Rate: 17.99%
  • Closing Costs: $0
  • APR: 17.99%

For purpose of comparing apples to apples, this scenario assumes the only debt on the credit card is the $15,000 assumed in other scenarios:


Most credit cards require a minimum payment between 1-3%, this example assumes the highest of that average to shorten the timeframe - if your card requires less than 3% and you make the minimum payment, the length of time, and Total Finance Charge will both increase. Using a credit card to pay off debt can be very expensive unless you have the cash flow to make much larger payments than are required.


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401k Loan: Debt Consolidation Scenario 3
credit cards
  • Low interest rate that you typically set
  • Fees and penalties may apply (would need considerable research)
  • Repayment term must be less than 5 years

Leveraging investments you've made in your 401k may be an option. It can be extremely complicated, and come with potential tax penalties, and of course in addition to potential interest rate savings to consolidate debt, there's also an opportunity cost (of not having that money growing through the investment). In addition, many plans prevent you from continuing to invest in a 401k when there is an outstanding loan. Therefore, this example is simply that - an example. Your specific scenario would require significant research in understanding the rules of what can be borrowed, if there are penalties involved, along with the interest rate you'll pay yourself back at, and how long you'll have to do so (and again, penalties associated with a scenario where you don't).

There are many factors to consider before taking a loan from your 401k:

  1. Can you continue to invest while you have an outstanding loan - some plans do not permit this, and it would be contrary to why you began saving in the first place.
  2. When you originally made the investment, it was likely tax-deferred, which means that taxes were not taken out of this portion of your income. Therefore, when you borrow from those funds, you may be subject to tax implications - especially if you are unable to make all of the payments to repay the loan, which would constitute an early withdrawal and then be subject to both additional taxes, as well as an early withdrawal penalty.
  3. A change in your employment status could result in the need to immediately repay the loan.

These are only a few of the considerations, it is recommended that you speak with your plan administrator, the human resources team at your company, or a personal tax advisor before proceeding. Let's say you've done that and are still considering this as an option to consolidate your debt - here's an example of what this could cost you:

  • Interest Rate: 6.00%
  • Closing Costs: $0
  • APR: 6.00%

There should be no closing costs, and you don't have to be approved since this is your money, but you do have to determine an interest rate that is acceptable by the plan administrator:


The Opportunity Cost is what that investment could have earned you over the 5 year period, so let's consider a few examples based on a $15,000 investment:


When considering a 401k to pay off existing debt, in addition to specific plan requirements and restrictions, the Total Cost comparison should include both the actual cost of the loan, and the opportunity cost of allowing your investment to grow. The examples above are meant to provide reasonable estimates to what the total cost of a 401k loan would likely cost.


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Cash-Out Mortgage Refinance: Debt Consolidation Scenario 4
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  • Low, tax-deductible (typically) interest rate
  • Mortgages include closing costs (can often be rolled into the new loan amount)
  • Repayment term typically 30 years

Many people may benefit from doing a cash-out refinance, which is available (in most States) for people who own their home, and are refinancing their existing mortgage. A cash out loan occurs when someone takes out additional equity (for more than the current mortgage) to pay off other debt. This can often be a great option for individuals, but only when the current interest rate makes sense based on the existing principle balance. Since mortgages are collateralized, interest rates can be much lower than a personal loan. We encourage clients to understand the option with and without taking cash-out and the overall impact of the additional cash needed to consolidate debt. For example, consider the following scenario:

If you were currently at a rate above 4%, and performed a refinance, the new payment (principle and interest only) for a 30-year fixed rate mortgage, would be:


In this example, there is additional equity that can be leveraged (in most states) to take additional cash-out in order to consolidate debt - using the same scenario as above, consider the impact of the additional $15,000:


In this example, we are assuming the exact same interest rate and term to compare apples-to-apples - there are factors that can be misleading, including the fact that the APR, which is lower with the same estimated fee, but the Total Finance Charge (including all interest in fees) is still higher:


So, what did the extra $15,000 cost when comparing the exact same mortgage offer?

  • The monthly payment increased by $71.61
  • The Total Finance Charge increased by $10,780.43, which represents the additional cost of the $15,000 taken as cash-out.

This option could make perfect sense, especially if the interest rate on the original mortgage is higher than the current rate, but in a scenario where you are just looking to take cash-out and keep the mortgage portion the same (or very close), this may not be the best option. We recommend that you compare the options of just a rate/term refinance and a cash-out refinance to ensure you're making the best financial decision. Another benefit is monthly cash flow, where a personal loan (while it is paid off more quickly) would have a higher monthly payment when compared to taking out a cash-out mortgage loan.

The point is that the true cost of borrowing $15,000 is certainly more with a cash-out refinance than it would be for a personal loan - even when comparing a personal loan APR at 17.3% to a mortgage APR at 4.2%.


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Summary: Debt Consolidation Loan Options

Don't be intimidated by factors like an interest rate or APR when comparing different types of loans. Seeing an unsecured interest rate (for a personal loan for example) may appear higher than other options, but calculating the Total Finance Charge for any of your options will ultimately present the best options. Obviously, your individual scenario may be driven based on current cash flow, so you may need to take a higher total cost, to reduce current monthly expenses, but if you're really looking for the best option, calculate costs for your individual scenario.

SUMMARY PERSONAL LOAN CREDIT CARD 401K LOAN CASH OUT MORTGAGE REFINANCE
Loan Amount $15,000 $15,000 $15,000 $15,000
Interest / APR 14.0% / 17.3% 17.99% / 17.99% 6.0% / 6.0% 4.00% / 4.228%
Month to repay loan 36 299 60 360
Total Finance Charge $4,130.92 $14,782.48 $6,543.74* $10,780.43
*Includes total cost of loan at 6% with reduction in earnings estimated at 5% annually

When considering the total cost of all viable options, your best bet to consolidate debt is usually a personal loan. A personal loan also encourages discipline, as it is a fixed monthly payment throughout the life of the loan, which helps you plan for the monthly payment, and can get you debt free with a lower total finance charge in just a few years. These examples are provided to provide relative options, and have been presented as accurately as possible. You should always perform the calculations based on your own specific options to determine what is best for you.




Last Updated: April 17, 2017

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