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Debt Consolidation: How To Combine Debts

By: Michael Millington

Debt can take on different forms which require different responses depending on individual circumstances. Some may be concerned about one big debt like a mortgage or a car loan. Meanwhile, others may be concerned about several smaller debts like credit cards, past-due bills, or similar issues that may add up to a large number. For those whose debts look like a death of a thousand paper cuts, debt consolidation may be the answer.


What Is Debt Consolidation?

Debt consolidation is similar to debt settlement (sufficiently so that the two terms are often used in place of the other), but there are some pretty pronounced differences between the two that should be cleared up to allow users to make the best decisions about this form of debt help. Debt settlement involves reducing the amount of an outstanding debt via negotiation with creditors, where creditors take less than the amount owed in exchange for getting it in a lump sum via a set-aside account that the debtor pays into regularly, often over the course of a few years.


Debt consolidation, meanwhile, deals with multiple debts, and calls for the debtor to take out one single loan to pay off the multiple smaller debts, focusing all the debtor’s effort to paying off the now-sole loan involved. The source of the larger loan to address the smaller loans can come from just about any source; it can be a personal loan, or it can be obtained via a bad credit loan or poor credit loan provider.


What Value Does Debt Consolidation Have?

The immediate value of debt consolidation is clear; there’s only one creditor involved instead of several smaller creditors to face down. This fact can make a debtor more focused and better able to keep track of their income. The problem is that there is one big debt that is much more difficult to pay down as opposed to several smaller bills that are individually easier to address. There are four key types of debt consolidation to consider, each with its own issues to consider.


A debt management plan offers users a complete plan to address the outstanding debt, and often comes with a credit counseling program or a similar education plan to help users better understand and use credit. Though a debt management plan can take three to five years to complete, the lessons learned therein can provide great value.


A balance transfer plan is particularly useful for credit card users, but is commonly only available to those with outstanding credit scores (usually a minimum of 700, by some reports). Though there may be a 0% interest rate involved that can be especially attractive, the interest can be replaced with a two to three percent balance transfer fee. That can be a substantial fee—for a $10,000 debt, the fee would be $200 to $300—and can make a bad situation worse.


A personal loan is essentially a peer-to-peer loan and can come from institutions like banks or credit unions, or even from private individuals. These loans come with a variety of interest rates but are commonly less than a credit card’s, making it attractive in terms of saving money on the interest to be paid back (assuming the interest on the outstanding loans will be higher than that of the personal loan). The collateral required to secure such a loan can vary and can be lost if the loan isn’t paid back.


A home equity loan is exactly what it sounds like: a means to borrow against the equity in your home. Home equity loans are also known for low interest rates due to the fact that failing to pay it back can result in the loss of the house. In that sense, the consequences of losing your house might act as great incentive to pay back the loan, hence the lower interest rates. There may also be some additional fees associated with this measure, including closing costs or application fees.


Ultimately, debt consolidation can be a valuable tool for those with large numbers of individual debts that together make up a fairly substantial amount. Some can find some value in this approach, while others may want to take the simpler approach of individual negotiations for more time to address all the loans in question. Debt settlement programs—including debt consolidation—come with their own set of pros and cons attached, so knowing about these and how they apply to an individual situation is vital to making the best decision in the end.


Written by Steve Anderson