What Is Debt Consolidation & How to Consolidate Your Debts?

Carl Packman

06.05.2024

Before the COVID 19 pandemic hit us, most financial advisors recommended people prioritize their debt payoff. But now, as millions of people worldwide lost their jobs, the focus has shifted to savings. The past two years showed us that it wasn’t only our health at risk but also our finances. Even those who were lucky enough to keep the jobs realized the severity of financial insecurity. Hence everyone became even more aware of the importance of having some money aside. Financial advisors recommend that we try to put aside three to six months’ worth of expenses. However, we can say that even having $1000 stashed in the savings account is a success. We need to admit, though, that it is hard to make a clear decision when you have a lot of debt and not many savings.

Of course, if you are making regular payments, your credit score will not suffer, and savings will prepare you for any surprises that might come in the future. But as we know, credit cards have high-interest rates. So, if you recently decided to stop paying your credit card balances, you can expect debt to accumulate.

One solution for this is to apply for personal loans through companies such as Loan Solution or other types of debt consolidation loans. Keep in mind, though, that while debt consolidation loan works as a lifeline for some people, it can create more debt for others. Before you decide to take this loan, you need to get well informed about what it is, how it works, and how it can help you.

What Does a Debt Consolidation Mean?

Debt consolidation is when you take a new loan to pay previous liabilities and consumer debts. So basically, debt consolidation means that all of your loans are combined as one debt. To cover those debts, you will ask for one of the debt consolidation programs. This type of loan usually comes with better payment terms such as lower interest rates, lower monthly payments, etc. This loan is a good option to cover credit card debts, student loans, etc. In general, debt consolidation loans come as fixed-rate loans, which means that you are paying the same amount of money each year regardless of inflation, deflation, or other financial issues.

To get a loan, you can contact traditional lenders like banks. Alternatively, you can turn to peer-to-peer lending companies. Getting a loan from the bank usually takes more time and effort since they have traditional standards all consumers must meet. Peer-to-peer lenders have slightly more relaxed regulations on who can get the loan. They also offer the opportunity for online debt consolidation.

Types of Debt Consolidation

There are two types of loans for consolidation of debt – secured and unsecured. When you are asking for a secured loan, you offer a lender some type of guarantee that you will pay back the loan. That can be a house, car, jewelry, depending on the amount of money requested. Unsecured loans aren’t backed with assets, so it might be difficult to get them. These types of loans also come with higher interest rates and lower qualifying amounts. However, it is also important to know that the interest is lower than the rate charged on credit card debts, whether you take security on an unsecured loan. The rates are also fixed in most cases. Here we will describe several most common ways to lump your debts.

Debt Consolidation Loan

Both traditional lenders like banks and peer-to-peer agencies approve debt consolidation personal loans. This payment plan is most commonly offered to people who find it challenging to get out of debt. They are technically created for people who want to pay multiple high-interest debts at once.

Balance Transfer Credit Card

A credit card balance transfer is ideal for those who have debts on multiple cards and don’t know how to get rid of them. In that case, you can open a new credit card and transfer all of your debts there. However, if you consider this option, you need to be prepared to pay additional fees. Also, there might be huge spikes in the interest rates if you are late with payments. This method of credit card debt consolidation is always possible. It is also good if a new card comes with lower interest rates. But this is not often the case, so it is important to know that it is not the best way to solve the problems.

Home Equity Loans

Home equity loans or home equity lines of credit can be interesting as a method of consolidation of debt for some people. This is a secured loan that enables you to borrow money in the value of your home, using equity as collateral. Equity is the difference between the market value of your home and the mortgage balance. Fixed equity loans come at fixed rates, while the equity line of credits has variable rates. A home equity loan is very similar to a mortgage, so people often call it a second mortgage.

Student Loan Consolidation

Finally, we arrived at the topic that interests many people: student loan debt consolidation. The government offers several debt consolidation options for people who have student loans. One option is to apply for direct consolidation loans through the Federal Direct Loan Program. However, this program doesn’t cover private loans.

How Does Debt Consolidation Work

In a way, we can say that debt consolidation is similar to credit card balance transfer because you are practically transferring all of your debts into one loan. However, there are some differences. For example, when you get a debt consolidation loan, the money is deposited into the bank account that you can use to pay off your debts at once. After that, you will continue paying your lender in monthly installments that you agreed to when you took the loan. When you pay off the loan, you don’t have access to the credit line. Regardless you ask for a loan from debt consolidation companies or a bank, and you will have to pay the fees. But it is essential to know that they are significantly lower than credit card interest rates. In general, the interest rates are calculated and divided into your monthly payments. On average, loan terms range between six months to seven years. Loans with longer terms generally have lower interests.

When Is Debt Consolidation a Good Idea?

When it becomes clear what it is, let’s see the pros and cons of debt consolidation. It is essential to know that the concept of consolidating debts isn’t for everyone. As you can see, there are several ways to consolidate debts, and each one comes with benefits and shortcomings. It is ideal for multiple debts with high-interest rates or monthly payments. It can be particularly practical for folks whose total debts exceed $10000.

When Debt Consolidation Is Not For You?

Although debt consolidation might look like an attractive way to become debt-free fast, it comes with some downsides. It is important to know them to answer whether debt consolidation is a good idea for you. For example, you need to be careful about the payment schedules. Choosing long payment schedules means that you will be paying more for a longer period. The best thing you can do is talk with a creditor to understand how long it will take to pay off the debt at the current interest rate. You can also use a debt consolidation calculator to find out whether this type of loan works for you. If you have little debts that you can pay off yourself in a certain amount of time, consolidation debt loans are not for you. In that case, you should maybe consider applying for a short-term loan like payday loans.

What’s Next?

Debt consolidation is a good idea when you have accumulated debts on different sides that you want to pay monthly. Nonetheless, even if they are convenient and simple, you need to pay attention to the interest rates and other fees that might come with this loan. If you are facing challenges to paying the loans you already have, there are no guarantees that you will be able to afford monthly payments for the consolidation loan. Before you make any decisions, check your income and current financial situation to ensure this is a good option.