A few weeks ago, I got a great question from a reader on Instagram that boils down to, “Does debt consolidation make sense here?”
Without getting into the specifics, they were asking whether it makes sense to pay off a smaller, high-interest debt over time, or to roll it into a lower-interest-rate line of credit and pay that bigger balance off over the long term.
And while there’s a clear “numbers” answer — a lower rate means you’ll pay less in interest over time — if you’ve read anything else I’ve written, you know that I think money is about feelings, too.
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There isn’t just one way to tackle debt.
In fact, there are two approaches so common they even have their own cute nicknames: the debt snowball and the debt avalanche.
Quick explainer: debt snowball vs. debt avalanche
A debt snowball is when you pay off your smallest debt first, to get a quick win under your belt. Once that small debt is gone, you apply the monthly payment for it to your next-smallest debt, and you start to gain momentum as you pay off your debts in order of size.
A debt avalanche is similar, but you start with your highest-interest-rate debt first. Once it’s paid off, you apply the payment to the debt with the second-highest interest rate, and move on from there. You’re paying cumulatively less in interest over time, but you might miss out on some of the motivation of seeing small debts cleared quickly if your highest-interest debt also happens to be a big one.
In the question I got, the person is asking whether the snowball approach makes sense, or if they should consolidate everything into one, avalanche-y debt pile to pay lower interest rates.
I can’t speak definitively to what would be more motivating to them — but I can speak definitively to some things that anyone needs to keep in mind if they’re looking at consolidating any debts, for any reason.
So whether you want to roll a line of credit into your mortgage, pay off a credit card with a line of credit, or some other fun combo of debt and debt, read on for the basic steps you need to commit to if you want to make debt consolidation work in your favour.
Pay attention to interest rates and technicalities
First things first: Can you even consolidate your debt?
It sounds like a great plan, and is often pitched as a simple and painless process, but debt products come with their own terms and conditions. Make sure to brush up on yours, including the terms of the product you’re planning to use for the consolidation.
You’ll want to look at the terms around balance transfers specifically, and more broadly you’ll want to make sure you know the exact interest rates you’re currently paying and will pay in the future.
Have a budget
I would argue that even when debt is used intentionally, like when we took out a car loan, no one loves being in debt.
It’s even less fun when it creeps up on you, which is why understanding how you got into debt is critical before you consolidate it. If paying off a credit card means you’ll see the zero balance and start spending on it again, only to rack up more debt, it’s not going to be the fix you hoped it would be.
To get started, write down a rough budget. This doesn’t have to be a line-by-line spreadsheet of how much you spend on shampoo every month, but you should tackle some big categories like bills, housing, food, restaurants, savings and fun spending.
Map those against how much money hits your bank account every month, and set budget amounts that feel sustainable and won’t have you spending and saving more than you earn.
Track your spending
However, budgeting isn’t going to be enough, especially if your debt is the sneaky kind that crept up on you.
You’ll also have to commit to tracking your spending, at least for the first month or two, to check whether the budget amounts you set are actually realistic. If they’re not, and you’re spending hundreds more on food than you expected (hey, it happens to the best of us, quarantine has been a grocery-budget destroyer for me) then that’s why your budget isn’t working.
But you’ll never figure out the root of the problem, or be able to fix it and prevent more debt, if you don’t track your spending. You can use simple tools like Mint, load your spending money onto a card like KOHO that tracks for you, or go full spreadsheet — but whatever you do, pick an approach you can stick to for at least two months.
Pro tip: I love my KOHO card as a fix for these overspending-by-accident situations. I used to consistently overspend my fun budget, so now I load the money onto my KOHO card each month. I know that when it’s gone, it’s gone — KOHO is a prepaid card, so I genuinely can’t spend more than I intend to. Perfect for the new lululemon leggings I “need” but don’t need, you know?
Track your debt balance
Along with tracking your spending, you’ll want to keep track of your debt balance, too. Specifically, you want to make sure it’s going down every month.
That seems obvious, but it’s one more way to make sure that your debt consolidation plan is doing what you want it to do: reducing the amount you owe. It’s a failsafe if your budget and your tracking aren’t helping — or if, over the long term, you’ve eased up a bit on them.
Most of the time, paying off debt is a marathon, not a sprint. You need to pick strategies that are sustainable, and keeping an eye on the total balance of your debt is a quick way to make sure it’s all going in the right direction.