By: Elisabeth Myrick, Contributing EditorFirst, what is debt consolidation really? In short, debt or loan consolidation is simple: you take out one loan to pay off many others. Why would you do this? Many times you can secure a fixed interest rate, a lower interest rate or simply for convenience. One of the most common examples of consolidated debt involves several credit cards, student loans and financed items (jewelry, furniture, etc.) all rolled into one loan with one monthly payment at a lower interest rate.
Debt consolidation can be as simple as moving several unsecured loans into one unsecured loan, but more often than not, it involves moving several unsecured loans into one secured loan, taken against an asset such as a house. This allows a lower interest rate for the consumer because they agree to foreclosure to pay back the loan if they are not able to make the monthly payments, which reduces risk for the lender.
For many people, debt consolidation is the easiest, least expensive and fastest way to get out of large debt. And sometimes, loan consolidation companies will discount the amount of the loan. This typically happens if the debtor is in danger of filing for bankruptcy and chooses to consolidate their debt. The debt consolidator can then buy the loan at a discount and some consolidators will pass part of the discount along.
Debt consolidation programs are recommended most for individuals who are paying off credit card debt, as most credit cards carry the highest interest rates. For those debtors with a home or car, those items can be used as collateral, resulting in a lower interest rate and less total money paid to pay off the debt.
The key points of debt consolidation programs for paying off credit card debt include:
Lower interest rates which equal lower payments. These types of loans and debt management programs will both lower your interest rates, as well as home equity loans or personal loans. The latter two sometimes offer lower rates than a credit card and can be used to pay off other bills. Some debt consolidation programs will also negotiate lower interest rates with creditors. These reduced rates will ultimately lower your monthly payment, however, it is important to continue paying as much as you can to lower debt quickly.
Temporary lower credit rating. As with any credit activity, taking out personal loans or enrolling in a debt management program will temporarily lower your credit score. This can be offset by closing other accounts, which is also recommended to manage future debt.
Open credit is tempting. By paying off accounts or transferring the balances, the open credit might be very tempting, however it is important not to use those accounts and focus on paying off the current debt. You can either close those accounts altogether, or remove the cards from your wallet and put them in a safe place.
Easy management. Paying one bill is much easier than paying 10. Instead of having multiple accounts to manage each month and bills to stay on top of, you have only one, with only one monthly payment.
Debt consolidation is a worthwhile solution to getting out of debt for many people. However, for consumers interested in using debt consolidation as a means to get out of debt, it is important to take steps to prevent winding up in the same situation a few years later. With loan consolidation should come debt management training. Look for a program that will help you learn to better manage your finances.
