How to Create a Debt Consolidation Plan

(August 16th, 2007)

If you owe various different creditors small to huge sums of money and find it difficult to keep track of each minimum monthly payment and interest rates, it would be in your best interests to consolidate under a debt consolidation loan that offers lower monthly interest rate and lower monthly payments. Instead of having to pay for example 5 different creditors, you will have to focus on making 1 monthly payment each month and reduce your debt. In order to successfully complete a debt consolidation plan, you have to be financially disciplined and plan out your monthly finances very carefully.

Debt Consolidation Plan

1) Analyze your Debt Loads

Make a list of all debts excluding your mortgage debt, towards which you are making your payments. For example, here is a scenario of typical household debts:

Credit card debt $8,500
Auto loan $21,000
Sears store credit card $2400
Total debt: $31,900

You should now add up the monthly payments you are making towards each of these debts. For example, we will assume that you are making 5% payments on each of these debts. Thus, here's the monthly payment schedule:

Credit card debt ($8,500 x 5%) $425
Auto loan ($21,000 x 5%) $1,050
Sears store credit card ($2,400 x 5%) $120
Total debt: $1,595

Here's the deal. In order for your debt consolidation plan to be successful, you need a total loan amount of $31,900 and the monthly payments you make towards that loan MUST be less than $1595 in order for it to be economically worthwhile.

2) Look for the best Debt Consolidation Loan

Here are the types of loans you should consider taking out under your debt consolidation plan:

a) Home Equity Line of Credit can offer the lowest interest rates available because your house is pledged as collateral, thus the bank can afford to lend money at lower interest rates because it can confiscate your house in case you default. The advantage of taking out a home equity line of credit is that the interest you make on this loan is tax-deductible, check with your tax accountant. For example, if you take out a home equity loan of $31,900 to pay off this loan, assuming you are charged 7% interest, your monthly payment over a 5 year amortization term will be:

Annual Interest = ($31,900 x 7%) =$2,233
Total Debt = ($31,900 + $2,233) = $34,133
5 year term = ($34,133 / 5 years) = $8534
Monthly payment = ($8,534 / 12) $711

b) Cash-Out Refinancing is another option available. With Cash-Out Refinancing, you take out a new mortgage on your home that is larger than the existing one you have. For example, if you currently have a mortgage loan of $100,000 while the value of your house is $150,000, you could take out a bigger mortgage loan of $131,900 ($100,000 for the mortgage loan on the house + $31,900 to pay off all your debts). With this strategy, your monthly mortgage payments will increase however you will end up saving a lot more money because of the fully paid off debts and less interest payments.

c) Personal Loans: With personal loans, your house is NOT pledged as collateral. Personal loans are a good option if you do not want to pledge your home as collateral or do not own a home yet. The interest rate you will get on these loans is higher than home equity loans but a lot better than credit card APRs (Annual Percentage Rates).

When considering any of the above 3 loans, take into account any closing costs as well as other fees and points that may inflate the cost of borrowing these loans.

3) Debt Consolidation Calculators

If you take out a home equity line of credit loan, use our Home Equity Debt Investment Calculator to compare your monthly savings between your original debt structures and your new debt consolidation loan that consolidates all of those debts. We will still use the example from Section (a) to perform an example:

Totals =
New Loan Information
Need Additional
Cash? If So
Enter Amount Here
of Years
Closing Costs
Fed & State
Tax Rates
Results Current New Loan
Total Principal Balance:
Effective Rate Before Taxes: % %
Effective Rate After Taxes: % %
Total Monthly Payments:
Monthly Tax Savings:
Monthly Payment Reduction:
Total Monthly Savings:


4) Remain Disciplined

At the beginning of this article, we said you need to have rigorous discipline and control your spending when taking out a debt consolidation loan. In order for your debt consolidation plan to be successful, you CANNOT afford to rack up more credit card debt. You should create a household budget to use every month to control your spending and do some cost cutting. Here is a complete article on Do It Yourself Debt Reduction.