Consumer Debt Consolidation

Written by Judy Moy

Consumer debt consolidation is a loan you take out to combine several smaller loans into a loan with a lower interest rate, longer period of time to pay, or a smaller payment amount.

This process can incorporate one or more of those financial strategies. It is important that as you consolidate the loans, you understand what your goals are. Are you doing this to simply lower your payments and interest, or to get out of debt faster?

Fewer Bills and Lower Payment

One of the biggest advantages to a debt consolidation loan is having fewer payments to make each month. Generally the new payment will be smaller than the total of the bills you are replacing. Debt Consolidation loans can be taken out with a bank, credit union or other financial institution.

You end up with a smaller payment because you have a longer time to pay off your debt, and often the interest rate is better than some of the other loans, especially if you are including credit card debt. The new loan should have a fixed interest rate and it can be very beneficial to consolidate your debt if you have an interest rate that fluctuates if.

First Steps

Before you get a new loan, it is important to know what you have. Sit down and make a list of each loan that you want to roll into a consolidation loan. On this list include the monthly payment, the interest for the current loan and what balance is left on this loan. This way you know the total balance and what interest rate you need to make the consolidation loan worthwhile.

Personal Loan

The consolidation loan might be one that you get from the credit union or bank. These are usually unsecured loans. An unsecured loan is one that is tied simply to your good name and credit. There is nothing “securing” the loan. These unsecured loans are often called personal or signature loans. Generally these types of loans are taken out for $5,000 or less. Pay attention to the term and interest rate. The goal is to get a rate that is lower than the debts you plan to pay off and to be able to do this in less than two or three years.

Secured Loan

A secured loan means that the loan is tied to something. It could be as simple as refinancing a car or other secured debt and adding an amount on top of the loan that you get back as cash. Then you use this cash to pay off several small loan amounts.

Securing a debt consolidation loan can also be done as part of a first or second mortgage. This means that when you buy or refinance a house, or take out a second mortgage, you add the amount you need to cover your short-term debt into the purchase price or refinance package.

So the asset securing this type of loan is your house. This can have the biggest impact on monthly savings. But be careful, it means all that short-term debt is now being paid off over 15 to 30 years and if you default on the loan, you could lose your house.

Collateralization Of The Loan

This is a fancy word for “securing” your debt with an asset like your house. But remember, the collateral that you use to secure the loan could be a car, boat, or even a savings account or CD that you have at the bank who gave you the loan.

Banks and loan companies like to have collateral attached to a loan. This is why a secured loan will have a smaller interest rate than the unsecured or personal loans. If the loan is secured, it is much easier to come and repossess your car, boat or simply seize your savings account—than it is to take you to court and try and get a judgment if you don’t pay an unsecured loan. The lender has less of a chance of losing their money, because they can just take your collateral, so you get a better rate.

Advantages

If you have several credit cards with double digit interest rates and several thousand dollars worth of debt, a consumer debt consolidation might make a huge impact on your outgoing monthly amount. The biggest impact would be to roll this debt into your mortgage, where you should be able to cut that double digit interest rate into less than half.

Disadvantages

If you’ve rolled your debt into your first or second mortgage you will be paying off that debt and the extra interest for fifteen to thirty years depending on how long your mortgage is for.

Make sure if you get money for a debt consolidation loan that you pay off the original debts and don’t just spend the money. This happens more than you would think and people end up in worse financial difficulty than they started.

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