Debt consolidation is a common type of strategy for dealing with debts that borrowers are having trouble paying off. The goal of debt consolidation and similar types of debt management is not to get rid of the debt through cancellation or forgiveness, but to find a way to pay off the debt fully and make debt problems more simplistic, easier to manage and budget for. Debt consolidation also can help improve credit and keep borrowers from resorting to bankruptcy.
Debt Consolidation
Debt consolidation seeks to replace old debts with a new debt. Sometimes consolidation creates a new loan in order to pay off one very large old loan, like a mortgage. At other times, consolidation uses new debt to pay off many different old liabilities, such as credit cards, auto loans and other smaller debts, which is how debt is "consolidated." The debt is not removed, but it is transferred to a new loan and allows borrowers to pay off problematic debts. Borrowers should consider this option when they have too many different kinds of debt, when debts are creating too much interest in their current form to be paid off easily, or when old debts have late payments that might lead to legal action.
Consolidation Sources
There are several different sources for debt consolidation. Some companies make a business of offering consolidation loans solely for replacing older debts. These private consolidation loans can come with high interest rates, so borrowers should investigate them carefully. Refinancing a mortgage or taking out a second mortgage also are common methods of raising funds for consolidation, although borrowers need good credit to use their home equity for this purpose. Fortunately, state and federal programs offer assistance for borrowers trying to refinance in order to consolidate.
Consolidation Goals
In the best circumstances, a debt consolidation does not only replace old loans and keep borrowers from having to default or face skyrocketing interest rates, but it also reduces overall debt. Borrowers should always seek a consolidation loan with a low interest rate. If the rate is lower than the combined effects of the old rates, then the debt will generate less interest, lowering monthly payments from their previous levels. Counseling services can help borrowers determine what rates will result in lower debt payments.
Other Debt Management Options
There are several options similar to consolidation, although they do not actually create new debt. These are typically referred to as debt negotiation or renegotiation and are effective methods of preventing foreclosure and dealing with debts that are currently too large to pay off. Borrowers with problematic debt should begin by talking with the organizations that hold the loans. Lenders may be willing to give borrowers space to reach better income levels or lower rates to make monthly payments easier to manage.
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