Debt consolidation loan is the process of combining all of your unsecured debts into a single monthly payment. This might be done with a debt consolidation loan .debt consolidation loan The loan is used to pay off your debts, then you pay off the new consolidation loan rather than dividing your payments to your creditors. You may be able to take out a debt consolidation on your own using a home equity loan or a debt consolidation loan from a bank.
Common Methods
Consolidating with a home equity loan can be risky since your unsecured debt comes secured by your home. If you can't afford the payments, your home could be foreclosed. That wouldn't happen if your unpaid debts remained on separate credit cards.1
If you hire a debt consolidation company, your loans may not necessarily be consolidated with a loan. Instead, your debts would remain separate, but your payment would be consolidated. You send one monthly payment to the debt consolidation company, then that company divides your payment and sends it to all your creditors.
It Does Not Reduce Your Debt
After consolidating your debt, you may feel like your debt burden has been lifted. However, it's important to remember that you still have the same amount of debt as before. Now, instead of having multiple accounts to pay, you have just one. This may ease the stress of managing multiple payments, but it doesn't mean your debt has lessened.
Pros and Cons
Debt consolidation is generally beneficiary only when the final consolidated debt has a lower monthly payment or interest rate, or both. While this makes it much easier to afford your monthly debt payment, it's often achieved by lengthening your repayment period. You'll ultimately end up paying on your debt longer than if you'd left your debt unconsolidated. The longer repayment period also means you'll also pay more total interest on your debt.
Be Alert
The debt consolidation industry is full of scams. It's easy to run into a company that may push you to get a high-interest-rate loan that costs more in the long run than paying your debts off on your own. Other companies pocket your monthly payment instead of sending it to your creditors, leaving you with damaged credit. It's important that you evaluate debt consolidation companies and their products carefully so that you don't end up in a worse situation than when you started.2
Many people who consolidate their debt often end up with new debt within a short period after consolidating. What's worse is they have this new debt on top of the debt they've consolidated, which compounds the debt problem. It happens because consolidating debt often frees up available credit, and many people cannot resist using it. If you consolidate your debt, it's better to close your old credit card accounts and focus only on paying off your consolidated debt.
Alternatives to Debt Consolidation
Some debt consolidation alternatives may allow you to pay off your debt sooner and save money on interest in the process.
Paying Your Debt on Your Own
It can be more difficult, but you can evaluate your debt and funds available to pay off your debt and create a plan to pay off your debts one account at a time. You can choose one debt on which to focus a larger payment every month, while paying the minimum amount on the others. Once you finish off that account, move the amount you were paying to that one over to the next account on your list, and so on until you have paid off all of it.
Use a Consumer Credit Counseling Service
Credit counselling agencies can negotiate a debt repayment plan with your creditors that reduces your interest rate and payment. You make one monthly payment to the credit counseling agency, and they pay your debt for you. You should still carefully investigate these services and make sure you only work with legitimate ones, however.3
Settling Your Debts
Debt settlement is a negotiating strategy where you pay your creditors a fraction of the outstanding debt to satisfy the account. Debt settlement might be a viable alternative if your accounts are charge off or in collections. You can do this on your own or through a company. This, of course, only works if you have the cash available to make one or a few large payments.
The Bottom Line
Debt consolidation is sometimes a good choice for getting yourself out of debt. But it's not the only option. Be sure you've thoroughly explored the alternatives and carefully researched any companies whose services you're considering. Otherwise, you could end up deeper in debt than you were before.
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