Debt consolidation is a financial method for paying off multiple creditors by taking out a new loan. The benefits of doing this are that the new loan may be at a lower interest rate, or at a fixed interest rate, or for the convenience of paying back only one loan.
Debt consolidation can be done several ways.
- One way is to roll the multiple debts into an unsecured loan.
- Rolling multiple debts into a secured loan against an asset that serves as collateral, most commonly a house.
In this case, a mortgage is secured against the house. The collateralization of the loan allows a lower interest rate than without it. In other words you, the asset owner, agree to allow the forced sale (foreclosure) of the asset to pay back the loan if you cannot make the payments otherwise. The risk to the lender is reduced so the interest rate offered is lower.
- A third way is to take multiple credit card debts and transfer them into a single card account.
In recent years, reports in the media have raised concerns about the use of consolidation loans. The worry is that many people are tempted to consolidate unsecured debt into secured debt, usually secured against their home. Although the monthly payments can often be lower, the total amount repaid is often significantly higher due to the long period of the loan.
Another disadvantage of is that, sometimes, it only addresses the symptoms of debt and does not address the root problem. In these cases, the debtor “eliminates” multiple credit card debts but does not close the card accounts. As a result, the old cards are used to run up new balances and the debtor is back where she started.
There are other alternatives to a loan. For example, debt can be eliminated through a settlement or payment plan.
Conclusion:
Debt consolidation can be confusing for many people, so it is helpful to learn about all of your options before entering into any legally binding agreements.
