Regardless of your financial situation or possibly the questionable choices you have made in the past, you have likely heard a great deal about debt consolidation as a way to potentially get back on solid footing. Before making any decisions, however, it is essential to learn precisely what debt consolidation is, how it works and the pros and cons of using it as a means to solve financial woes.
Debt consolidation is a process through which an individual secures one large loan that will be used to repay all smaller outstanding debts. The end result is that a borrower has just one payment to make each month instead of having to juggle several different payments to multiple creditors. In addition, these loans are intended to offer lower interest rates that a borrower is currently paying on their other loans. This, hypothetically, results in more rapid repayment and emergence from debt.
Debt consolidation can thus provide an opportunity to clear the decks, so to speak, and make debt repayment much more simplified and maybe even more affordable. The key, however, is to approach the process armed with sufficient knowledge in order to sidestep some of the pitfalls many encounter when attempting to consolidate many debts into one.
One of the first decisions that will need to be made is whether to consolidate debt by securing an unsecured loan or a secured one. Secured loans are those in which the borrower must pledge an asset of some sort, perhaps a primary residence, to guarantee repayment of the new loan. If the loan is not repaid, the security asset will be seized by the lender. Unsecured loans are those granted in exchange for just a promise to repay, and which do not result in forfeiture of collateral in the event of default.
It is quite common for debtors to consolidate debt by taking out a secured loan. One of the most common ways in which this is done is through second mortgages or home equity lines of credit. There are also lenders who make loans secured by car titles, though these tend to be for smaller amounts than many people need to truly consolidate all debt. Life insurance policies with cash value can often be used as security for new loans as well.
Secured loans such as those described above may offer lower interest rates than unsecured financing, and thus they may help borrowers achieve the overall goal of reducing interest payments in a broad sense. Monthly payments will likely be lower and thus more manageable.
However, the negative side of using a secured loan as a means to consolidate high interest debt is the fact that should default occur, even due to circumstances beyond your control, you will lose the asset used to guarantee repayment. If your house was used as collateral, your life is surely going to be turned upside down. In addition, it is important to make certain that the term of a secured loan is not longer than that of the other debts being consolidated. Otherwise, you may end up paying more interest in total than you would have paid on all of the separate obligations.
While it may be possible for some borrowers to consolidate debt by using unsecured loans, the option is not as widely available as in the past. Considering that most people looking to consolidate lots of high interest debt likely have lower credit ratings, unsecured loans are often hard to obtain. In addition, because they are not secured by hard assets, these loans tend to carry significantly higher interest rates. This can ultimately defeat the purpose of rolling other debts into one.
Taking advantage of promotional low-interest credit card consolidation offers can be a good way to reduce interest payments, but only if you do so with great care. In many instances, lenders tack on substantial fees that limit the positive impact on your overall bottom line. In addition, these offers are often limited in duration, and if the consolidated balance is not repaid before the offer expires, a much higher interest rate will take effect, potentially negating the benefits altogether.
For the financial savvy individual, debt consolidation can be a terrific way to get a handle on their finances once and for all and make amends for poor decisions made in the past. It can allow debtors to enjoy a simplified payment schedule and lower interest rates if done properly. The sense of relief that comes from paying off several debts at once can be liberating indeed.
More Information about Debt Consolidation
However, if you decide to go this route, it is critical that you do not let yourself get lulled into a false sense of financial security. Having all of your credit card accounts show a zero balance due may tempt you to go on a shopping spree which could put you right back where you started if you are not careful.