Consumers considering debt consolidation as a way to handle their debt should understand the process before getting involved. Whether debt consolidation is appropriate for you depends on the kind of consolidation method you use and the agreement you negotiate with your creditor. When you understand your options, you can determine whether consolidation is a viable way to get your debt under control.
Definition
Debt consolidation is the process of moving several high interest credit card debts into a single monthly payment. You can create your own consolidation plan using a personal loan, a lower interest credit account, a home equity loan or line of credit. You can choose to work with a debt consolidation professional, who can help you create a program that will consolidate your debt either through a loan product or through a program set up and administered by the debt consolidation professional.
Consideration
When determining whether debt consolidation is a bad option for you, you have to understand the potential consequences of each program. If you work with a credit counselor or debt consolidation specialist who puts you on a consolidation program, that can show up on your credit report as a negative mark, according to Jenny McCune, writing for the Bankrate website. If your credit score is already suffering from your recent payment history, trying to get a loan on your own at an interest rate that will save you money will be difficult. Taking a hit on your credit score or getting involved in a loan that will cost you more than your individual credit accounts can be a bad financial move.
Warning
Developing a consolidation program on your own can be an attractive way to take care of your debt, because you avoid the fees paid to a debt consolidation professional, and you will not add a negative mark to your credit report. One consolidating loan for which you may qualify is a secured personal loan. A secured personal loan is backed by your personal property, which would be used as collateral. If you default on that consolidation loan, you will lose that property. The same applies to refinancing your mortgage to include the consolidation of your debt. If you default, you will lose your home. You should understand the terms of the program before signing a loan agreement.
Effects
When you consolidate credit accounts, those accounts remain active but their balances are paid off and become part of a different monthly loan payment. Do not close those accounts. Leave them open and use them from time to time in a controlled manner. Only charge as much as you can pay off in a month. Using your existing credit cards, even in a limited capacity, will help to raise your credit score as you pay off your consolidation program. Also, your credit utilization (the percentage of the debt you carry relative to your credit limit, also called debt-to-credit ratio) has an impact on your credit score. If you close those accounts, your available credit is reduced so your credit utilization percentage rises, which hurts your score.
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