How does debt consolidation work?

You have probably heard of debt consolidation at some point, and may have a vague idea of what one is. Most people, when they hear those two words, think, “great, another loan. That’s all I need”.  It doesn’t quite work that way, and it can really help you out if you’re in a bind with several debts that don’t seem to be going anywhere, no matter what you do. Lot’s of people have misconceptions about how payoff personal loans can help, among other services, so allow us to tackle that subject now and explain just how the whole thing really works.

Debt consolidation: the concept


The whole point of debt consolidation is to enable those who are having difficulties managing their various debts, to group together (or, consolidate) these debts into one payment rather than several that are hard to keep track of, and end up costing more. Most people just find it easier, also, to look after just the one loan instead of several each month. Not only that, as mentioned above, by grouping these bills together into one you are likely to obtain lower payment amounts each month compared to paying everything separately.

As an example, let’s say that you have 3 credit cards and they have interest rates of 12%, 18% and 25% respectively. By grouping these debts together, you may end up with a monthly interest rate of 10% or 15% which is going to save you a fair amount of money over the life of the loan repayments.

In a similar vein, consolidation of your loans can also help to lower the minimum monthly payment. This is helpful especially for those that are struggling to meet the minimum monthly requirements of the existing loans. If you have been missing payments, and incurring fees as a result, this would provide much needed breathing room, and opportunity to get things back on track in other areas so you are not left worrying about things on top of the debt.

It is worth keeping in mind though, that while a consolidation loan can help in a very real and big way, lower monthly payments will mean it will take slightly longer to pay it all back and it could also mean paying more interest in the long run – although that is not set in stone if the interest rates are also lower.

Where do you get a consolidation loan?


The link in at the top of this piece will help a lot, but there are other places. The majority of debt consolidation loans deal with student loans and credit card debt, but they can be applied to other forms of debt too. There are a number of companies out there in the wild that provide the debt consolidation services that you may need, of which these include:


  • Mortgage lenders
  • Credit card companies (yep)
  • Peer-to-peer lenders
  • Debt management companies
  • Banks


Mortgage providers will often, as you may expect, provide a consolidation loan secured against your home. This kind of loan uses your home equity, and is called a Home Equity Line of Credit. Generally speaking, these types of loans have a more favorable interest rate than other types of debt consolidation loan but the risk is also higher – after all, if you fail to keep up with the repayments, you run the very real risk of losing your home.

Another option that is open to some people, is to take on all of the debt onto a credit card. This can be via a transfer, in the case of other card debts, or by simply paying off debts using the credit card and then just paying off the one debt that you are now left with.

This method can either be very good, or incredibly bad. In the case of transfers, it is very often the case that there will be a 0% interest fee, for upto 12 months, on balances that are transferred. This is excellent if you can pay it all off within that timeframe, but not so great if you cannot. This can end up being an expensive option if you can’t pay it quickly because some credit card companies will charge interest on the entire balance, retroactively; which includes amounts you have already paid off.

What is your best bet for debt consolidation


Ok, let’s assume that you are not totally confident that you can pay off the debt in the time period that a credit card balance transfer will allow and that you either do not have a mortgage or you don’t like the idea of putting your home in the line of fire/ What happens now?

A peer-to-peer solution may well be the best way for you to move forward. A peer-to-peer loan is different than those offered by debt management companies. The biggest difference is that there are no hidden, or ‘extra’ charges and they very often offer much better interest rates than any bank you would care to think of.

Will debt consolidation hurt your credit score?


While the majority of consolidation loans will not affect your score in a negative way, since the outstanding debts are still being paid, the approval process may include what’s called a hard credit check. All credit checks of this nature impact your credit score, taking off a few points each time and these can stay off for upto two years.

In the end, the only thing that will have a negative impact on your credit score is you. It seems obvious, but to protect those three digits you have to make making regular, on time re-payments a priority – after rent / mortgage and food, naturally, and don’t forget car and gas payments if you need your vehicle to get to work!

Debt consolidation can be a great help if you allow it to be, just be sure to make payments each month to make sure it keeps working for you, and not against you.

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Sidney Deserres

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