What You Must Know About Debt Consolidation

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Debt consolidation is the process of combining all your unsecured debts into a single monthly payment. Debt consolidation might be done with a debt consolidation loan. The loan is used to pay off your debts, then you pay off the new consolidation loan rather than dividing your payments to your creditors. You may be able to take out a debt consolidation on your own using the a home equity loan or a debt consolidation loan from a bank.

Common Debt Consolidation Methods

Consolidating with a home equity loan can be risky since your unsecured debt comes secured by your home. If you can't afford the payments, your home could be foreclosed. That wouldn't happen if your unpaid debts remained on separate credit cards.

If you hire a debt consolidation company, your loans may not necessarily be consolidated with a loan. Instead, your debts remain separate, but your payment is consolidated. You send one monthly payment to the debt consolidation company then that company divides your payment and sends it to all your creditors.

Debt Consolidation Does Not Reduce Your Debt

After consolidating your debt, you may feel like your debt burden has lifted. However, it's important to remember that you still have the same amount of debt as before. Now, instead of having multiple accounts to pay, you have just one.

Debt Consolidation is Better and Worse

Debt consolidation is generally beneficial only when the final consolidated debt has a lower monthly payment or interest rate or both.

While this makes it much easier to afford your monthly debt payment, it's often achieved by lengthening your repayment period. You'll ultimately end up paying on your debt longer than if you'd left your debt unconsolidated. The longer repayment period also means you'll also pay more interest on your debt.

What to Watch Out For

The debt consolidation industry is full of scams. It's easy to run into a company who may push you to get a high interest rate loan that really costs more in the long run than paying your debts off on your own. Other companies pocket your monthly payment instead of sending it to your creditors, leaving you with damaged credit. It's important that you evaluate debt consolidation companies and their products carefully so that you don't end up in a worse situation than when you started.

Many people who consolidate their debt often end up back into debt within a short period of time after consolidating. What's worse is that they have this new debt on top of the debt they've consolidated which compounds the debt problem. This happens because consolidating debt often frees up available credit and many people cannot resist using it. If you consolidate your debt, it's better to close your old credit card accounts and focus only on paying off your consolidated debt.

Alternatives to Debt Consolidation

Some debt consolidation alternatives may allow you to pay off your debt sooner and save money on interest in the process.

Paying your debt on your own. It can be more difficult, but you can evaluate your debt and funds available to pay off your debt and create a plan to pay off your debts one account at a time.

Use a consumer credit counseling service. Credit counseling agencies can negotiate a debt repayment plan with your creditors that reduces your interest rate and payment. You make one monthly payment to the credit counseling agency and they pay your debt for you.

Settling your debts. Debt settlement is a negotiating strategy where you pay your creditors a fraction of the outstanding debt to satisfy the account. Debt settlement might be a viable alternative if your accounts are charged-off or in collections. You can do this on your own or through a company.