How to Consolidate Your Debt

"One can pay back the loan of gold, but one dies
forever in debt to those who are kind."

Malayan Proverb

In contrast to credit counseling, is debt consolidation. Usually for many, this is the fist step they take to fix their credit score, and it involves turning all of the person's debts into one big debt. This may seem like an odd thing to do, but it makes perfect sense.

The debt consolidation process involves taking out one big loan to pay off many other loans. This is done so that the debtor can have a lower interest rate and have a fixed interest rate, as well as the convenience of one loan instead of several.

Debt consolidation can involve many different methods. One such method is simply an unsecured loan that is made up of many other unsecured loans, or it can be a secured loan that uses an asset as collateral, usually someone's house. In most cases, that would be the mortgage being secured against the house to get the loan. Putting the loan in one large sum like this gives a lower interest rate because the owner will agree to foreclosure of the asset to pay back the loan. Therefore, from the lender's point of view, there is little risk to a default on the loan.

One good thing about the debt consolidation loan is that some companies will be able to discount the loan amount. If the debtor is in danger of bankruptcy, the debt consolidator can get the loan at a discount; this is why, when a debtor is looking for a debt consolidation company, they need to do their research.

When To Get It?

One of the best times for an individual to get debt consolidation, is when they are dealing with many different credit cards. The reason for this is as follows:

If someone has five credit cards that owe the following: $2,000, $3,000, $10,000, $8,000 and $5,000, then they are going to owe $28,000 on their loans. The interest is as follows:

1. $2,000 10.5 percent

2. $3,000 11.2 percent

3. $10,000 8.9 percent

4. $5,000 17.3 percent

5. $8,000 15.1 percent

Interested in learning more? Why not take an online Understanding and Managing Your Personal Credit course?

This means that the total debt is $28,000, and the total interest is:

1. $210

2. $336

3. $890

4. $865

5. $1,208

Therefore, the total interest on a $28,000 loan comes to $3,509. This can also be found by averaging out the interest, and then multiplying that by the credit owed (only off by a few dollars).

This is a lot of interest to be paying on these credit cards, and that can easily send someone into a debt spiral.

Therefore, going into debt consolidation using a secured loan with the house as collateral can probably get an interest rate of only eight percent. Which creates this amount of interest:

$28,000 x .08 = $2,240. This means that the amount of interest that has to be paid is an astonishing $1,249 less! This is what makes debt consolidation great.

The above example shows how a debt consolidation loan can help someone, simply through the reduced interest rate. This is not even taking into consideration the possibility of getting a lower debt amount through the threat of bankruptcy.

Predatory Lending

Like credit counseling, there will be people out there who will try and take advantage of the difficult situation some people are in with debt and credit. Some companies will offer the debtor a high-interest debt balance, taking advantage of the benefit of refinancing to charge high fees in the debt consolidation loan. These can be near the maximum that is allowed for mortgage fees. There are even some companies out there that will wait until the debtor is against the wall, and has no options available to them other than refinancing to a debt consolidation loan, to pay off bills that have fallen behind. The reason they are against the wall is because if they do not refinance, they may lose their house, and therefore are willing to pay any fee for the debt consolidation.

Since the debtor is in such a difficult spot, they may not have the time, or the know-how, to shop for another company with lower fees.

Thankfully, most debt consolidation companies do not practice this.

Loans Versus Debt Consolidation

Many people will choose to simply take out a loan, instead of going into debt consolidation, because they think that the programs, debt settlement, and laws concerning debt consolidation are simply too confusing. However, trying to get a loan that works to pay off a person's debts is often a difficult task. As well, debt consolidation companies can negotiate lower interest rates. Since the debtors are having credit trouble, their interest on the loan can be too much, or even exceed the interest on all the other loans (by average).

Debt consolidation programs are debt repayment programs, and the company someone uses will negotiate more favorable repayment terms on the accounts to reduce interest rates, and even eliminate late fees.

Overall, the debt consolidation path is a good one for an individual, but it is simply a home equity loan in disguise. The equity on the home loan is built up and it is used to pay unsecured debts. These can have large application fees and can actually extend the time that someone will be paying off the debts, but they work for many people because they make paying back loans that much easier.