About Debt Consolidation
In financial circles, the definition of debt consolidation or a consolidation loan looks like this: it’s a "strategy used by a consumer to manage their debt," or it’s a “process of combining several loans or liabilities into one loan.”
Note the words strategy and process. Strategy implies that you know what you’re trying to accomplish and are taking proactive measures to reach certain goals. Process on the other hand leaves you feeling as if you are being pushed and pulled along some giant stairwell that takes you where you really don’t want to go.
No matter what definition you use, debt consolidation means that instead of paying off several separate bills each month, you plan to consolidate your loans with a bank, credit union, or other financial institution. The reason for doing this is to get one payment that is smaller than the combined total of all the other payments.
The smaller payment occurs because the debt has a longer time to be paid, or possibly provides you with a better interest rate. You might want to consolidate your debt to secure a fixed interest rate if one or more of your smaller loans have fluctuating rates.
The first step in consolidating your debts is to know what you have. Make a list of each loan and include the overall balance, the monthly payment and the interest for the current loan. This allows you to know what your situation is now, before you make a decision on a new loan.
The new loan might be an unsecured loan, or you may be refinancing cars or other secured items and adding an amount that will allow you to pay off a few smaller loans. Unsecured loans are sometimes called signature loans, or personal loans.
Securing the loan means tying it to an asset. Debt Consolidation can be done as part of a first or second mortgage. This allows you to roll short-term debt into a home mortgage loan, either when you buy the house or later as part of a refinance package or second mortgage.
For a mortgage, the asset is your house. But again, the asset could be a car, or boat, or even savings CDs that you have at the bank giving you the loan. Another word for asset is collateral and securing a loan with this collateral is sometimes called ‘collateralization’ of the loan.
Usually securing the loan with an asset or some collateral allows you to get a lower interest rate than you would get with an unsecured loan. This is because if you fail to make your payments, the lender – either a bank or other financial institution – can take the asset from you and sell it to get their money back. Since the lender has a reduced risk of losing their money, you get a lower interest rate for your loan.
Loan consolidation can be very advantageous if you have several small loans with higher interest rates. For instance the balance on your credit cards runs to several thousand dollars and the interest is in double digits. If you roll it into a home mortgage, you might be able to cut the interest rates in half. The downside is you pay that interest on the balance for fifteen or more years, depending on the term of the mortgage.
Debt Consolidation sometimes occurs when people or businesses have credit problems. It is important that if you get a loan to pay off smaller loans that you actually take the money and pay off those loans. Many people get into trouble when they decide to do a consolidation loan and then spend the money somewhere else. This leaves them with all the old loans, and a new payment.
Referencing the definitions at the beginning of the article, debt consolidation can be a strategy, or a process. Do your research and ask questions. Read all the information on the company and consolidation loan you’re considering, and make an informed decision, then you can be proactive and strategize your next move. Or you can scramble, let the ‘process’ drive your moves and go with the first thing that comes along.
Which definition do you want your debt consolidation to be? Is this going to be a strategy or a process?
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