Debt Consolidation – the Basics, from Barron Advisors

Estimated reading time: 5 mins

Dealing with debt through debt consolidation is a process where we combine all of our unsecured (i.e. not mortgages, title loans, etc) debts into one single (and hopefully more manageable) payment – monthly is standard. Debt consolidation is often manifested as a debt consolidation loan – a special type of loan with an obvious, single purpose. These loans are used to pay off our ‘expensive’ debts (at a high interest and penalties), and we then pay off the new consolidation loan rather than dividing our payments to our creditors. So it simplifies the loan, too.

We may choose to take out a debt consolidation loan secured against our home, or other asset, using what is known as a Home Equity Loan. It can be very risky since our unsecured debt is then secured by our home. If we can’t afford the payments, our home could be foreclosed (taken back by the bank and we can no longer live in the home!) Foreclosure doesn’t happen if our unpaid unsecured debts were to remain on individual loans or credit cards.

Barron Advisors: The common methods of Debt Consolidation

Banks may off you a debt consolidation loan – these tend to be home equity loans. They can be be arranged with your bank and done directly through them. As long as you can evidence how you will pay off the loan and maintain payments on the agreed basis, they are fairly simple to arrange as you already will have a relationship with your bank.

Hiring a Debt Consolidation Company to assist you, instead of your bank, your loans may not always be consolidated with a single debt consolidation loan. Dependent on your circumstances, the company may instead conclude that your debts should remain separate (as now), but the payment from you is consolidated, and then distributed. It works like this: you send a single payment (will almost always be monthly) to the debt consolidation company; in tune, that company takes your payment and divides it between all your creditors and sends them a repayment. The debt consolidation company deals with the actual payment process and ensures that there is the right priority and discipline in the process.

Debt Consolidation doesn’t wipe clean your debts

There is a myth that debt consolidation wipes clean, or reduces debt. Our debts must still be repaid!

After consolidating your debt into one debt or repayment, there is a very understandable feeling of relief. The worry and anxiety might simply disappear. What’s really important, though, is to now maintain your commitments to the consolidated debts, as you now might be on your ‘last chance’ to resolve your debt problems. Particularly now if your home depends on it. You will still have the same amount of debt as before (possibly even more if fees are added on top of your debt.) But now at least, instead of having a multitude of separate debts to ensure payments against, you have a single payment to get right. Don’t mess this one up!

Pros and Cons of Debt Consolidation

Barron Advisors: Pros of Debt Consolidation

  • Debt consolidation reduces your monthly payment or interest rate, or both
  • This makes it much easier to afford your monthly debt payment
  • One company to deal with rather than multiple – less relationships to manage
  • It’s easier to see the effect of a repayment against the entire debt
  • Less stress!

Barron Advisors: Cons of Debt Consolidation

  • Debt consolidation is often achieved by lengthening the time it takes to repay the debt, when compared to not consolidating and leaving the debts as they are
  • The longer your repayment period means that you’ll also be certain to pay more interest, in hard cash, on your debt even when the interest rate has been reduced. This is the trade off that you must be aware of
  • Will mean a longer period when your home or other secured assets are at risk

A Warning on unscrupulous Debt Consolidation Companies

The debt consolidation industry is full of companies intent on scamming people out of their cash (can you believe it?) These outfits are kicking people when they are down! These companies don’t help anybody, but themselves. A common tactic of theirs is to scare or bully people into taking on a high-interest rate loan – which ends up costing even more in the long term than if you were to pay off your debts as they stand today. Other companies have been reported to simply hold on to monthly payments, for themselves, instead of distributing it amongst creditors. Not only does this rob people of their badly needed money, it also results in a damaged credit rating. What’s really important is to do your homework and check out the reputations of debt consolidation companies before doing business with them.

Avoid the debt cycle

Sadly, many people who consolidate their debt will often end up back in a position of unmanageable debt after a short period, resulting in brand new debt on top of the consolidated old debts. It goes back to what I said before, that feeling of relief brings about a more hopeful outlook, and when combined with the newly freed up credit, lots of people go about spending again and using up their credit. The warning is that debt consolidation requires a new discipline, or it will have no effect other than to make matters worse. Cut up your credit cards!

Alternatives to debt consolidation

Some debt consolidation alternatives may be even better for you and should always be considered before taking on a debt consolidation solution.

Settling your debts by negotiation

‘Debt settlement’ (sometimes known as ‘debt negotiation’ or ‘debt arbitrage’) is a way of negotiating your debts so that you pay your creditors less than the full outstanding debt to satisfy the account, and once done so, the debt is considered as paid in full. This approach really is about asking creditors to wipe away some of the debt. This doesn’t come ‘for free’ as it almost always results in a ‘default’ being recorded against you and a bad credit rating for seven years.

Use a Consumer Credit Counseling Service

Consumer credit counseling services are provided by agencies that negotiate a debt repayment plan, on your behalf, with your creditors. The aim is to reduce your interest rate and payment. Many of these agencies operate as non-profit. Like debt consolidation, you make regular payments to the credit counseling agency, and in turn, they make payments to your creditors for you.

Paying your debts, as they are, on your own

There still remains the option for you to continue servicing your debts are they are. With the alternatives (and their respective costs and penalties in mind) it may still be the best thing is to continue as is. It will probably require major adjustments in your life in order to make continued payments!

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