What Does It Mean to Consolidate Your Debt?

Debt consolidation combines multiple bills into a single monthly payment. The primary reasons for consolidating debt are to obtain a lower interest rate and simplify the debt payments. Debt consolidation is common among people with credit problems and companies with maxed out business credit cards. Credit card debt consolidation is perhaps the most beneficial, as credits cards tend to carry some of the highest interest rates.

Credit Cards and Banks

The most common way to consolidate debt is to combine smaller high interest credit card debts in to one lower interest loan. Banks offer loans to help you consolidate debt. Bank consolidation loans come with predetermined amortization, meaning a set monthly schedule of payments that will decrease the total debt over a certain period of time. A common practice is to assess the debtor's home equity in order to consolidate using lines of credit, a second mortgage or refinance the original mortgage.

Home Equity Loans

Home equity loans or lines or credit may seem like an easy way out of debt, encouraging consumers to leverage their property value with money back and tax break incentives. However, individuals should be very careful when dealing with this type of debt consolidation, as borrowing money against property value can be a big risk. If the loan is defaulted for any reason, including hardship or missed payments, the homeowner runs the risk of losing the house. Even though interest rates are tax deductible, it still does not always make financial sense to go into debt in order to pay off other debt. Examine the numbers carefully to ensure the move will save you money, and most importantly, make all payments on time to keep the loan healthy.

Zero-Percent Credit

Individuals without home equity often turn to zero-percent credit cards to consolidate their debt. However, discipline and prudence is still highly advised. Credit card companies use these rates as incentives to lure consumers into a credit card account that might take decades to pay off. These companies are also looking for people with a better credit score, so those with very poor credit do not have this option. Zero or low interest rates will not always stay that way. In order to keep the low interest rate, you most make sure all payments are paid on time, as even one late payment can raise the interest rate significantly. Also, the agreement might indicate that the interest rate rises after a few months or a year, so read the fine print. Individuals taking on this type of debt consolidation should beware of hidden fees and charges. This really only works if individuals are meticulous about their payments and pay more than the minimum amount the credit card requires to pay off the debt as fast as possible.

Consolidation Loan

Consolidation loans are widely advertised online and in the mail. Often, this type of debt consolidation lures debtors with promises of convenience. However, you need to be absolutely sure that the bundled loan will in fact be less than what you already owe and pay each month. This type of loan might have higher interest rates than what you pay now if you do not have home equity or good credit. Calculate all the interest and fees on your currents debts and compare those calculations to the loan terms. It is also smart to shop around for the most suitable loan terms and conditions.