How Debt Consolidation Programs Work (The Truth)

You’ve probably seen those commercials which state that you can consolidate your debt into one easy payment each month. It sounds like a great deal, right? Well, that’s certainly the case for some people, but debt consolidation isn’t the ideal solution for every situation.

Here we take a look at how debt consolidation works, its benefits and disadvantages.

When a lot of people enter into or consider debt consolidation, they really don’t understand how debt consolidation programs work. They assume that it’ll fix every problem for them and that they won’t have to worry about the debt, which isn’t the case. That’s why anyone who is even remotely considering debt consolidation programs should arm themselves with all necessary information. In this article, we’ll cover the basics of how debt consolidation programs work.

Debt Consolidation – The Basics

Debt consolidation is not at all like debt management plans. That’s because with a debt management plan, a credit counseling agency contacts the creditors and gets them to lower interest rates. Then you give money to the credit counseling agency and they disperse it to creditors. That’s not the case with debt consolidation.

With debt consolidation, you are essentially taking out one big loan and then placing all your other loans on this loan, thus creating one big loan which has to be paid off. Depending on the interest rates of your debt, this can be quite beneficial—if you can get a big loan with a fair interest rate. You’ll be paying one big monthly payment each month which takes care of your debt for that month.

So, to sum it up, you’ll be transferring all your debt to one loan and then repaying that.

How Does It Work?

You’ll have to first find a financial institution that offers debt consolidation. Don’t think, though, that they will grant you a huge loan without anything being done on your part. You’ll have to put up some sort of collateral to make the deal worth their while. This collateral usually comes in the form of a house.

Once you secure a loan, they’ll basically put all your debt on the loan and they’ll tell you how much to pay each month for the loan. How much you pay depends on the interest rate, time and total amount of debt.

Should I Consider Debt Consolidation?

There really isn’t a one-size fits all answer to this question. Who should and shouldn’t consider debt consolidation depends on the situation. Before considering debt consolidation, you should ask yourself the following questions:

• Is it best for me to get a loan than to pay off the debt on my own?
• Have I looked into alternate methods of paying off my debt like debt management plans? Would these plans be a better fit for me?
• Am I comfortable with the possibility of losing my home if I miss a payment on my debt consolidation loan?
• Am I OK with potentially hurting my credit by getting a debt consolidation loan?
• Have I fully researched debt consolidation loans and do I know the possible harmful effects of them?

If you’ve carefully and thoroughly gone through the above questions and still feel as though you should go with debt consolidation, then it’s time to go over the benefits and hazards of debt consolidation.

Benefits of Debt Consolidation Programs

If you have several credit cards, it’s probably hard for you to remember to pay each one every month. In fact, it can be downright impossible to get everything straight month after month. The bills seem to just keep piling up and you’re overwhelmed by it.

Debt consolidation can change all this. It can consolidate all your bills into one easy to remember monthly payment. It’s very convenient.

Another benefit to debt consolidation, besides the convenience, is that it can actually take care of your debt in a quicker time than you could by paying it off by yourself. That’s because you can usually get a debt consolidation loan with an interest rate of between 3% and 10%. Considering the fact that most credit cards feature rates of 10-25%, debt consolidation can result in big savings and a quicker repayment time.

Debt consolidation loans can also be pretty flexible. Depending on the financial institution, you may be able to set up the loan so that it can be repaid over a set period of time. This allows you to somewhat tweak the loan depending on your unique situation.

Hazards and Pitfalls

Just like the song says, every rose has its thorn. Debt consolidation, while a great solution for some, has its downsides. The most obvious downside is that you’ll have to put up collateral, such as a house and vehicle. If you miss even one debt consolidation loan payment, you risk having your house taken away from you. That’s a huge risk.

Another bad thing about debt consolidation is that it initially negatively affects your credit score. That’s because you are taking out a huge loan (and taking out a loan always initially hurts your score) at one time. Even after you’ve paid off your loan, it’ll still show up on your credit report for a period of time and potential lenders may be inclined not to grant you credit if they see that you had to resort to a debt consolidation program to pay off your debt.

Where Can I Get a Debt Consolidation Loan?

Many financial institutions (banks, credit unions etc.) offer debt consolidation loans. If you want to get the best possible deal on your loan, you should try several different places.

At first, you’ll want to go to your local credit union or bank. You can ask them what they offer in the way of debt consolidation loans. Also ask what kind of interest rate they would give you, as well as the repayment plan and what collateral is necessary. One tip is to go to a bank or credit union which you are not a member of. They may give you an excellent interest rate in order to win your business.

The online banking market is extremely competitive, so you’ll also want to look online for debt consolidation programs. You may be able to get an even lower rate online than you could by going to a local bank or credit union. Just make sure to do a lot of research on any online bank to make sure they are legitimate and won’t scam you.