How Debt Consolidation Works

About once a week, I do some Internet research to find out what topics people are researching online (relevant to this blog). Debt consolidation is always at the top of the list of financial topics. The reasons why are fairly obvious. Millions of Americans are dealing with excessive amounts of debt, and they are looking for solutions.

In today’s lesson, I’ll explain how debt consolidation works and when it’s worth pursuing. If need immediate help in this area, use the link above to schedule a free consultation. If you simply want to learn more about this subject, then read on!

How It Works – The Basics

The concept behind debt consolidation is a fairly simple one. Basically, you are combining various forms of debt (such as credit cards) and replacing them with a single source of financing. The most common example of this is when people take out a loan to pay off multiple credit accounts. This is referred to as a consolidation loan, because it consolidates many types of debt into a single debt. This is just one example of many, and also the most common method.

Home equity loans and zero-balance credit card transfers are other ways to consolidate your debt. Regardless of what form it takes, there’s a key concept you must understand. Debt consolidation works by combining various accounts into one. It doesn’t make the debt go away — it just rolls it up into some other form. But it can bring certain benefits under the right conditions, so let’s talk about those next.

Benefits of Debt Consolidation

We’ve discussed how debt consolidation works, in its most basic form. But why do people do it in the first place? What are the primary benefits of consolidating debt? There are some benefits, but before we get into them we need to cover an important point. There are right and wrong ways to use debt consolidation. I don’t want you to think it’s a magical cure that works in all cases and for all people. With that being said, there are two key benefits of consolidating debt:

• Convenience — When you replace various forms of a debt with a singular one, you are making your life a lot easier. Less accounts to manage, less bills and statements to read, less payments to make. These are all good things.
• Savings — If you use debt consolidation wisely, it can also save you money. This is especially true when you replace various high-interest accounts (such as credit cards) with a lower-interest loan. The principal amount owed might be the same, but you’ll pay less interest on that amount.

The credit card scenario mentioned above is a common one. It’s an example of when consolidation makes sense. If you can make your life easier by reducing bills and paperwork, while also saving money by reducing interest payments, then a debt consolidation might be a good option.

The Dangers of Consolidating

I’ve said it several times already, but I’ll say it again. There are right and wrong ways to handle your debt. When consolidation is done wrong, you could find yourself with bigger financial problems than you started with. If you ask me, one of the worst things you can do is tapping your home equity to pay off credit card debts. This is why it’s so important to understand how debt consolidation works, and how to use it wisely.

In the equity loan scenario, you are basically replacing an unsecured debt (such as credit card balances) with a debt that is secured / backed by your home. In other words, you are putting your home at risk to pay off your credit cards. I would advise against such a strategy. A low-interest consolidation loan is a better strategy than tapping your equity in this way.

Get Free Advice on Consolidation

The best advice I can give you is to seek counseling on the subject, before you make any decisions. You can get debt advice for free in many cases, or for a very low cost. Non-profit organizations, such as the National Foundation for Credit Counseling, offer debt counseling services to consumers. You can also sign up for a free counseling phone call through Credit.com, which is another direction I recommend (see below):