Consolidating debt can be a useful part of a debt repayment program. Consolidation is useful for people with debt from a number of different sources, usually several credit cards. Consolidating debt can help people who are unable to manage their monthly payments by giving them the opportunity to have one lower monthly payment instead of several higher ones. This usually costs more money in the long run because more interest is paid. Consolidating debt can also result in paying back less over time, if debt is consolidated at a lower interest rate.
Personal Loans
Debt consolidation refers to any situation in which you borrow money from one source in order to pay off multiple debts. It is often done for student loan debt or credit card debt. One method of consolidating debt is to take a personal loan, or a consolidation loan. Personal loans from banks can be used to pay off credit cards and other higher interest personal loans. Special loans, called consolidation loans, are also available from banks, private companies and the government to consolidate student loan debt. Personal loans can either lower your payments by stretching out the term of repayment, or lower the amount you pay by offering you a lower interest rate than you are paying on your debts. Typically, you have to apply for and be approved for a personal loan. Then once you receive the money, you can pay all of your other creditors (although with student loan consolidation, the money you borrow is usually paid directly to the other loan companies).
Balance Transfers
Balance transfers involve transferring the balance from one credit card or loan to another. This can be advantageous because often creditors will offer incentives to transfer balances to their company. These incentives usually take the form of special introductory rates for a set period of time, e.g. a company might offer 0 percent for six months or 1.99 percent for the life of the balance. Usually, a fee is associated with transferring a balance, which is a percentage of the amount transferred. The fee usually is capped (there is an upper limit). After the promotional period, the interest rate is usually high, so it is important to pay off the balance transfer within the promotional period. If you miss a payment, typically, you lose the promotional rate, so it is essential to pay on time. In addition, as of August 2009, payments are applied to lower interest debt first with most credit card companies. This means if you make a standard purchase at the standard annual percentage rate, or APR, any payments you make will not be applied to that purchase until the entire balance transfer is paid off, so the purchase will be accruing interest for the duration of that time.
Home Equity
It is also possible to consolidate debt by borrowing against the value of your home, increasing the amount you owe on your house, but eliminating your other debts. You can consolidate debts using the equity from your home by taking out a second mortgage or a home equity loan or line of credit. The interest rates on these types of loans are usually lower than personal loans, and the interest may be tax deductible. However, these are secured debts. Credit card debt is unsecured, which means if you fail to pay the debt, the lender can take your home. This is relatively risky unless you are confident you can pay off the debt.
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