Debt consolidation programs are loans taken out by a consumer, in which the new loan is used to pay off other smaller loans. The aim of the loan is usually to consolidate multiple debt payments into one payment, in order to make the debt a little more manageable.
History
It can be difficult for people to believe that at one time personal debt as a lifestyle was considered a moral shortcoming.
In the first half of the 20th century, growing suburban sprawl necessitated automobile ownership for commuters, and the desire for home ownership (and all the modern conveniences therein) brought about a mass acceptance of revolving credit. Our great-grandparents would no doubt be horrified at what we as modern consumers consider necessities. Be that as it may, easy access to credit has become the norm in modern society, so it's no surprise that the business of credit and debt management has become an industry in itself.
Benefits
People often feel more at ease with a single loan payment than they do trying to juggle multiple bills with different due dates; one statement can certainly make debt feel more manageable. If the new loan term is longer, the payment will be lower, which can also free up cash for other uses. Also, if a secured debt consolidation loan or a home equity line of credit is being used to pay off multiple credit card debts, the new interest rate will likely be lower than that of the credit cards, which means long-term savings on the amount of interest paid. Unlike payments on credit cards, the interest paid on home equity loans is tax deductible, just as it is on your first mortgage.
Function
When deciding to apply for a debt consolidation loan, it's a good idea to shop around for the best deal. A good place to start is banks that you already have a relationship with; since you're already banking with them, the paperwork involved should be straightforward and largely stress-free. If their terms aren't satisfactory, competing banks or credit unions may be prepared to offer a better deal in order to win your business. In either case, managing your credit is a very important. To obtain the best rate, it's essential that your credit scores are as high as possible. You can facilitate this by making sure that your debts are paid in a timely manner, and also by clearing up any unfair black marks on your credit report; a little upfront legal work here can pay dividends in the long run.
Considerations
It's important to consider how long you'll be paying interest on the new loan. While opting for a longer term loan will certainly lower the monthly loan payment, it will also increase the total amount of interest paid over the life of the loan. Rolling outstanding debt owed on a car into a new consolidation loan may be a relief initially, but it's worth considering how it might feel 15 or 20 years down the road, when the car is likely no longer in use. For someone in dire need of immediate cash flow, the trade-off may be worth it, but it's not a decision to be made lightly.
Warning
Since the loans used for debt consolidation purposes are often home equity loans secured by an applicant's home, it's important to be mindful of the risks of such a loan. Credit card companies can't take your home from you, but failing to maintain a timely payment schedule on a loan secured by your home could lead to the bank foreclosing on the home.
When several creditors are paid off with the proceeds of the new loan, it can often feel like the debts have been erased and often this gives rise to a false sense of security. A smaller, single payment can easily lead to further abuse of credit cards that all of the sudden have zero balances. If the temptation to continue to use credit cards is strong and you start using other credit cards again, there will once again be multiple bills coming to you, which defeats the purpose of the debt consolidation.
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