Finance Q&A: Should You Get a Debt-Consolidation Loan?

Dear Deborah,

Q: After years of renting, I was able to buy a house. I took out a home improvement loan to do some remodeling and to buy new furniture. I also have a car loan. Do you think I should get a debt-consolidation loan so I just have one loan to pay? I'm 50 and single. --

Sue

A: Are you able to make the monthly payments without any hardship? If so, I would discourage you from consolidating.

Getting a debt-consolidation loan will stretch out your loan payments over a longer length of time, and the interest rate may be higher.

When borrowers get a consolidation loan they often continue with their old spending patterns. They mistakenly think that with the financial pressure off them they can let up their guard.

Another drawback is the consolidation loan's presence on your credit record. Potential lenders assume that you may have poor spending habits and that they're taking a bigger risk as a lender.

Since it appears that you can handle your payments every month, work to pay off each loan early. Begin an aggressive debt-reduction plan. Make a list of your loans, your monthly payments, and the total balance due for each one.

Develop a tight yet manageable budget. Take the extra funds and pay down the loan with the smallest balance. Set a goal to have the loan paid off as quickly as possible. When the first loan is repaid, take that dollar amount and work on paying off your second loan early, and so on.

If you follow this workable plan, you'll have your loans paid off even faster than you imagined. You can then work on setting aside 3 to 6 months' worth of expenses in savings. You can do it!

Dear Deborah,

Q: I work for a company that offers a 401(k). Should I put all my extra investment money in it? -- John

A: I suggest that you not stash all your spare money in your 401(k) plan. Definitely contribute up to your company's full match, usually 3%-5%, considered "free money" toward retirement. Maximize this avenue of savings.

But don't max out your 401(k). Plan payouts are taxed at ordinary income rates instead of the lower rates (15% top) for capital gains and dividends.

It's better to put any extra retirement savings into a Roth IRA where you can earn and withdraw your money tax-free. You can open an account with a mutual fund, broker, bank, or credit union.

By contributing to the 401(k) and Roth IRA, you'll diversify your tax strategy, with tax-deferred funds and income tax-free funds.

Copyright 2009 Deborah Nayrocker. All rights reserved. Permission to reprint required.

September 25, 2009.

Deborah Nayrocker is the author of The Art of Debt-Free Living - Living Large on Less than You Earn and Living a Balanced Financial Life.