When a person owes money to multiple creditors, he may consider consolidating his debts into a single debt. This can be done by approaching a finance company that offers consolidation loans. Under consolidation loans, the finance company will buy off an individual's current debts and issue him a new, larger debt. Taking on a single debt, particularly one with a low interest rate, can be financially advantageous to the debtor, as long as he understands the new loan's terms.
Debt Consolidation
When a finance company consolidates a person's debts, it is essentially allowing the person to exchange his current debts for a single new loan. When negotiating the consolidation, the person agrees to take out this new loan under specific terms. The person will agree to pay a specific rate of interest on the loan and pay back the loan over a certain period of time. Often, consolidation loans will last longer but be structured so the payment sizes are smaller.
Interest Rates
Often a person will be able to get a consolidation loan with a lower rate of interest than his current loans. This does not necessarily mean that the person will be paying less money over the long term. In fact, in exchange for lowering the person's interest rates, the lending company will likely increase the overall size of the borrower's debt burden. So while individual payments are less, the total payment on the loan is more.
Payment Sizes
Finance companies are able to offer smaller payment sizes on the loan by lengthening the total life of the loan. So several loans, each of which is designed to be paid back over five years, may be consolidated by the finance company into a single loan that will be paid back over 10 years. The borrower will be paying less per month but will paying back the loan for a longer period of time, meaning he will ultimately pay more money that he would had be not consolidated his debts.
Considerations
Unless a consolidation loan is being issued by a nonprofit company, the borrower can expect to end up paying more on this loan than he would were he to pay each of his outstanding loans separately, as his new lender is seeking to make a profit. If the borrower is falling behind on his current loan obligations and chalking up late fees, however, it may behoove him to consolidate his loan into one with smaller payments.
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