What is Debt Consolidation?

Published by Thomas Herold in Economics, Laws & Regulations

'Debt Consolidation' is explained in detail and with examples in the Laws & Regulations edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.

Debt consolidation is combining all of an individual’s personal debts into a single larger debt. When people go though debt consolidation, they obtain one loan which they then use to pay down all smaller loans or outstanding debts. The idea is that this provides consumers with only a single payment that they make once per month. This is supposed to be simpler for consumers to pay and manage.

A main goal with debt consolidation is to obtain a lower interest rate. The monthly payment generally becomes lower through the process as well. Despite the fact that the payment is lower, the debt can be repaid faster. The lower interest rate makes this possible.

Debt consolidation is different from debt settlement. In debt settlement, higher outstanding bills are negotiated to lower more manageable amounts. In debt consolidation, individuals fully pay off all of their bills. There are no bad impacts on credit history and reports as a result of the consolidation process.

Consumers pursue debt consolidation through either an unsecured or a secured loan. An unsecured loan does not involve any collateral. This means that no personal assets back the loan. The lender extends the loan because the individual pledges to repay it. A credit card is a prime example of an unsecured loan. Many credit cards offer debt consolidation with a lower promotional interest rate to their customers. In general, the rates are higher on unsecured loans. This is because the risk is greater for the lender with an unsecured loan than with a secured loan.

With a secured loan, individuals receive the debt consolidation funds because they pledge an asset. These assets that secure the loan are usually a car or a home. Car loans and mortgages are both secured forms of loans. The downside to a secured loan is that a lender can seize the asset if consumers fall behind on the loan.

Debt consolidation with a secured loan happens through a variety of different types of loans. Among the more popular secured debt consolidation loans is a second mortgage home loan or a home equity line of credit. It is also possible to obtain a debt consolidation loan with a 401k. In this type of loan, retirement funds are the asset that underlies the loan. Insurance policies allow owners to take loans against the value in the policy as well.

Annuities are another vehicle that can sometimes be borrowed against. A number of special financing companies also issue loans against lottery winnings or lawsuit claims. In each of these cases, the element in common is that the asset secures the debt consolidation loan.

There are both pros and cons to consolidating bills with an unsecured loan. The biggest difficulty with these types of loans is obtaining them. Unsecured loans require fantastic credit in order to qualify. The interest rates are typically higher than those on secured loans as well. Still the rates are often lower than the ones charged by high interest credit cards. If these consolidation rates are not substantially lower than those of the bills on the debt consolidation loan, then it may not make a difference in the payments and payoff time-frame.

Debt consolidation loans that rely on credit card balance transfers can present problems. It is important to be aware of what happens after the promotional balance expires. The new interest rate may be so high that the loan does not provide any benefits over the terms of the old debts. There are commonly transfer fees with these credit card balance transfers. These can eat up a part of the savings that the debt consolidation should provide.

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The term 'Debt Consolidation' is included in the Laws & Regulations edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.