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Debt consolidation allows you to consolidate your unsecured loans, bills and credit card debts into one (usually lower) payment, while saving in interest and credit fees. It is the process of combining all outstanding debts (including medical bills and credit card debt) and replacing them with one single loan from a new lender. The goal is to reduce monthly payments by spreading the debt repayment over a longer repayment period and reducing the interest rate to be paid. For example, a person may take out a $18,000 loan and use it to pay off debts including $6,500 on a high interest loan, $11,000 on credit cards and $500 on a store credit card. The benefits of a lower interest rate can be lost if the loan is amortized over a longer period than is absolutely necessary.
The first step in debt consolidation is to get a clear picture of exactly what you owe, what your living expenses are and what your income is. Then you will need to clearly analyze your situation. A careful evaluation will show you what your next step will need to be and if debt consolidation will work for you. If you need to proceed with consolidation, you should prepare by finding out what your FICO score is, what interest rates you can expect to be charged, and what services are available.
(See below for more information.)
Consumers have a number of choices when consolidating debt. If you own a home, vacation property or other real estate you can use it as collateral and apply for a first or second mortgage to pay off your existing debt. If you do not own real estate, you can apply for a personal loan to pay off your debts or hire a debt counsellor to negotiate with creditors on your behalf. Most credit counseling agencies have developed relationships with major creditors and can negotiate on your behalf to reduce or eliminate interest payments; stop late payment fees; and reduce monthly payments.
Consolidation can save you money over time, provided you resist the temptation to re-accumulate debt. Let's take a look at an example. Let's say you have a gas card with a balance of $400 at 18%, a Visa with $6000 at 14%, a Master Card with $8000 at 15.9%, and another card with $6500 at 22%. You owe a total of $20,900. You borrow $20,900 from your bank on the equity in your home at 12%, pay off your loans and write-off the interest paid at the end of the year as a tax deduction.
Another option, the cash-out mortgage refinance, is a loan tacked onto a new mortgage. This is a good option, but one you should only consider if you planning to refinance your mortgage to begin with, since there are costs involved. For example, if you paid 16% interest on a $10,000 credit card debt it would take nearly five years, paying $250 per month (and $4,400 in interest) to satisfy the loan. That same loan amount, charged at 2.59%, would be paid off in approximately three-and-a-half years.
Negotiating a solution to mounting debt is not always easy, but it can be done, either on your own, or with the help of a debt consolidation service. The important thing, is to face your debt and begin to deal with it. |
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