Debt Consolidation Blog

An important strategy for staying out of debt is to have cash reserves. This is money in your bank account that you can easily get to for unexpected emergencies.

How Much Should You Keep in Cash Reserves

Some people suggest keeping enough money to live on for 6 months in cash reserves. The downside of this is that your money may make better interest somewhere else. I would suggest keeping your money in a place that earns the most interest (short term CD, money market, etc.) If you have to give some type of notice before pulling the money out, you might consider keeping just enough in a savings account to cover you until you can get to the money that is invested with a better return.

What is the cash reserve for

The cash reserve isn’t for going on vacation or paying for a new TV. It is there to help keep you from going into debt if you run into an unexpected major expense. For example, if the refrigerator goes out or you have a big medical bill that isn’t covered by insurance or you lose your job and have trouble finding another. Ideally you should never have to draw on your cash reserve, but it keeps you from going into debt when unexpected emergencies come up.

Where do I get the Money to put into the Reserve

If you don’t have any money to put into the reserve you’ll have to grow it over time. This is probably going to mean cutting back in other areas so you can save. On the bright side of things, if you get use to putting 10% of your income into a savings account, imagine how good it will feel once you finally get a cash reserve built up and then you can put that money toward retirement or something else.

How Important is a Cash Reserve

Usually people don’t go into debt just for the fun of it. But it doesn’t take many emergencies to put a family well beyond what they can reasonable pay back. The cash reserve keeps you from having to take out loans. Every time you take out a loan, you automatically owe more money than what you got in the loan. If you have to pay a high interest rate, it may only take one or two major expenses to put you so far behind that it is going to be very difficult to dig your way back out. It is better to be frugal ahead of time than have to cut back because you’ll lose your house.

For small amounts of debt, you may be able to consolidate on your own. If you have money that you can get to, you can use it to pay off your debts. Here are some sources of self funded debt consolidation.

Home Equity Loan

Sometimes you can take out a loan against the equity you already have in your house. This is usually some of the least expensive ways to borrow money because your house is collateral.

Retirement Funds for Debt Consolidation

Certain types of retirement funds will allow you to borrow against them or take withdrawals when you have financial problems. Once again this can be some of the least expensive money. In some cases you will be charged interest, but the interest goes to your account, so you are basically paying yourself interest on your debt consolidation loan.

Using Relatives for Debt Consolidation

This can be a very bad idea because it can ruin your relationship with your close relatives. However taking out a loan from a relative at a lower interest rate than your current loans and using the money to pay off the current loans, can be a financially wise way to consolidate your debt. Just make sure you understand how it will impact your relationship and handle the loan professionally as you would with a bank.

Selling Assets for Debt Consolidation

Selling off assets can be a great way to get out of debt. Technically it isn’t debt consolidation because you are eliminating debt instead of just consolidating it. Selling off an extra vehicle, furniture, a boat, electronics, or even your house can be a financially wise decision. If you are able to sell something that isn’t an asset (something that will go down in value) this is a great idea. Your non-assets will be worth less in the future than they are right now. By selling them you can take the current value and wipe out your debt for that amount. This effectively turns them into assets because they save you money in the future, so it is as if they become worth more.

Most people look for debt consolidation after they get in trouble. The best plan is to avoid getting into a situation where debt consolidation becomes necessary. The more you can avoid bad debts the less likely you’ll need debt consolidation services.

In general assets that appreciate are the only places you should take out a loan. For example, taking out a loan for a home, is usually reasonable. Having a mortgage is unlikely to put you in financial difficulties if the rest of your finances are being handled correctly.

Banks know that mortgages are usually not a bad place for people to borrow money, so they don’t charge much in interest for those types of loans. On the other hand, banks know that borrowing money for consumer electronics is a very bad place to borrow money. They charge you a very high rate on your credit card purchases.

If you can stay out of debt, you can stay away from debt consolidation. One of the most tricky things to value is your car. Automobiles are important for you to be able to work, but they are not assets. Your car will not be worth more in 5 years than it is now. The ideal thing to do is to buy a car with cash. If you get a good deal on a used car that has been well taken care of, this can be a great way to go. If you have to finance your car, do your best to pay it off as soon as possible. Watch out for debt consolidation where you will end up bundling the car loan with your home loan and paying on it for 30 years–your car definitely isn’t going to last that long and bundling things that depreciate in with your assets is a sure fire way to make sure you stay in debt indefinitely.

Debt consolidation can have its place. There are some people who use debt consolidation to get out of financial difficulties when they are facing bankruptcy. If you can plan ahead and avoid getting into bad financial situations in the first place, you will be much better off then trying to use debt consolidation later on.