What is Debt Consolidation?

If you have a number of outstanding debts, you may be considering debt consolidation. What exactly is debt consolidation and how can it affect your finances both now and in the future? In a nutshell, debt consolidation occurs when you take out one loan to pay off several others. Most of the time, an individual will consolidate debt in order to secure a lower interest rate or to secure a fixed interest rate. Some people consolidate because it's easier to focus on one loan instead of trying to juggle multiple loans at once.

Debt consolidation can be from a number of unsecured loans into another unsecured loan, but more often than not, the debt is consolidated into a secured loan. A secured loan requires the borrower to pledge an asset that serves as collateral. Most of the time, secured loans carry a lower interest rate, because the risk to the lender is reduced due to collateralization. However, don't forget the risk you assume when you pledge assets as collateral, because you could potentially lose your house, car, retirement fund, or whatever else you have put on the line to secure the loan.

Options for Debt Consolidation

For people who find themselves in over their head financially, debt consolidation is an attractive option. By consolidating your debts into one loan at the lowest possible interest rate, your debt does not grow as fast and a greater amount of each payment you make covers the principal versus the accrued interest every month.

It is important to choose the right debt consolidation program for your situation, because if you don't choose wisely, you could actually increase your monthly payments or pay more in added interest before the debt is paid off. Plus, your credit could be damaged if you don't complete your consolidation plan or make all payments on time. If you are interested in debt consolidation, be sure you manage the payment plan, so you do not accrue fees or more interest. The goal of consolidation is to avoid taking on more debt.

Many people consider debt consolidation when they have a significant amount of credit card debt. The ease of buying things on credit can be a dangerous trap, because you may not consider whether you can really afford what you're buying. After failing to pay several bills, you could be facing some serious debt. However, consolidating debt alone does not get you out of debt. In many ways, consolidation is a quick fix for a much larger problem. If you truly want to break the cycle of debt, you need to get your spending habits under control.

A Great Way to Get out of Debt

You can consolidate your debt for free by getting a new loan or low-interest credit card, so do not fall into the trap of paying expensive fees to a debt-consolidation service. There are also well-regarded nonprofit consumer credit-counseling organizations that can help you consolidate your debt in the smartest way possible and at little cost. The organization can talk with creditors to negotiate more favorable terms in order to help you get out of debt faster and at a lower cost. Credit-counseling organizations can also manage your payments, so you have less of a chance to miss or be late on a payment.

Prior to consolidating your debt, take a long, hard look at your options and determine whether consolidation will truly save you money in the long run. You may experience a great deal of emotional and financial relief by consolidating your debts into one lower monthly payment, but you can't get ahead of yourself and let your guard down. The last thing you want to do is incur additional debt before you have taken care of your consolidation loan. In the end, consolidation loans are beneficial if you can be disciplined enough to change your habits and avoid slipping back into debt.