What is debt consolidation?

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Refinancing, which is generally a term applied to home loans and mortgages, is essentially the acquiring of a new loan to pay off an old loan. In most cases, this new loan will boast a lower interest rate or updated conditions that suit the borrower. Debt consolidation, on the other hand, is a term typically applied to personal and student loans. Again, the practice involves taking out a loan to pay off other previous debts or a series of loans, but in this case it is consolidated into one simple payment.

 

“The practice involves taking out a loan to pay off other previous debts or a series of loans, but in this case it is consolidated into one simple payment.”

Various types of debt consolidation:

  • Banks and credit unions will offer debt consolidation loans, specifically tailored for the sole purpose of combining debts. Debt consolidation loans ideally have a lower interest rate than the one you are currently paying.
  • A home equity loan or line of credit is another common type of debt consolidation. Since the loan is secured by the equity you hold in your home, the lender is therefore able to give you a lower interest rate.
  • In most instances, people acquire a personal loan is in order to consolidate their debt. However, with this kind of loan it may be difficult to find an interest rate that is low enough to save you money in the long run.
  • A credit card balance transfer is another option. It involves transferring all your credit card balances onto a single card, thus you may be entitled to a lower rate – perhaps even a promotional rate.

What kind of risks are involved?

While this practice may be advantageous in certain situations, it may present a series of unexpected risks, thereby requiring careful attention to a series of details. In order to understand the risks involved in the process, let us first review the actual definition of debt consolidation and the situations in which individuals and companies select this option as a solution for their economic issues. Let’s take, for instance, the average college graduate, considering his or her typical loan situation, both in and out of college.

In the United States, there are currently about 37 million student loan borrowers with outstanding loans. In Quarter 1 of 2012, nearly one-quarter of borrowers owed more than $28,000; 10% owed more than $54,000; up to the 1 percentile, owing a startling $200,000. Once out of college, the average starting salary amounts to $45,327, leaving each of these categories with endless years of monthly payments to cover their loans, and especially interest rates. If we take a moment to add these sums to the subsequent mortgage payments, we begin to understand the attraction that many individuals have to the concept of debt consolidation.

Is debt consolidation the option for me?

When dealing with multiple loans and interest rates, debt consolidation begins to seem like an attractive solution. Oftentimes, it is done to secure a lower interest rate or simply a fixed rate. Sometimes it may involve the act of securing a loan against an asset that serves as collateral, in other words a house. There are a myriad of popular TV commercials or subway advertisements publicizing “fast and easy” ways to “cut your payments in half” or “get you out of debt”. Unfortunately, these apparent solutions sometimes bring about the worst of scenarios, including further debt, higher rates, and worse yet, losing one’s home.

Therefore, before diving headfirst into a debt consolidation program, be prepared. Go over your finances carefully and review your credit report attentively. Consider all of your options and consult a credit counseling agency. Analyze the best loan for your financial situation and, most importantly, aim to pay off the debt quickly. But before choosing one debt consolidation program, make sure you’ve shopped around and found the most convenient. Last but not least, make sure you carefully read the fine print. It’s often the contractual section that offers the most important information!

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