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Understanding Debt Consolidation

No one wants to get there, but many people will find themselves with bills that are more than they can pay at some point in their life. Debts go unpaid, the late fees pile up, and eventually some people are in over their head and feel as if they will never be able to satisfy their obligations to their creditors. For people who are in this situation, debt consolidation may be the solution to their problems.

Debt consolidation works by combining all of a person’s debt into one loan, often at a substantially lower interest rate than was the average of the interest charged on the debts before consolidation. With one loan comes one fixed payment each month, a payment that is low enough for the consumer to afford. As this one loan is paid, the debt level goes down and the debtor finally is able to get ahead.

There are many reasons why people might look at debt consolidation. The first could be labeled as just simple carelessness. It is easy to apply for credit card after credit card and max out the limits on them. If we are not careful, we soon end up living way beyond our means, but this can only be done for a limited amount of time before the interest starts eating us out of house and home.

Others need debt consolidation because some tragedy has forced them to take out loans. This is commonly the case in the event of a serious illness when people have to use credit cards or set up a payment plan with a hospital to pay for a life-saving surgery or other treatment. Once all is well once more, debtors may find themselves way over their heads in debt.

A final reason why some people find debt consolidation necessary is that they are just tired of paying high interest rates. Consolidating the debt allows them to save much money on the long run because the interest they are paying on their bills is substantially lower.

As with just about anything in life, debt consolidation has certain pros and cons. Saving money, as we have already seen, is the main pro of debt consolidation. Another is that debt consolidation loans will not hurt a person’s credit score. On the other hand, the main con when it comes to debt consolidation is that combining the debts into one does not by itself lead to responsible debt management. Many people who consolidate debt quickly end up in their heads once again because, having a lower payment as a result of the consolidation, they begin racking up the debts once more.

Those who are interested in debt consolidation have several options. Homeowners can take out a home equity loan if they have enough equity in their home to borrow against. There are also third-party agencies that will negotiate with creditors to consolidate a loan on a consumer’s behalf. These are not always a good option because with them often come additional fees for their services. Personal loans from friends and family are yet another option for the consumer.

In the event that debt consolidation is not possible for the customer, or even if debt consolidation will not lower the monthly payment required to meet the debt, there is always the option of debt settlement. Creditors would rather get paid back some of the money they are owed instead of losing it all, so they will often settle a debt for a lower amount than what is actually owed. Debtors can contact their creditors directly to work out a plan, and if one is agreed upon, then the debtor should make sure to get a letter from the creditor signing off on the debt. Third-party companies also exist to settle debt on behalf of debtors, but again there come fees with this that can be avoided when debtors are willing and able to contact their creditors on their own. It must be noted that settling a debt instead of paying it in full will lower a debtor’s credit score, but not to the degree that a bankruptcy will.

Finally, if debt consolidation and debt settlement are not an option, the debtor should look into filing bankruptcy. Under a bankruptcy, most debts are canceled, although there are a few that are exempt. This may sound nice, but a bankruptcy stays on a credit report for seven years, making it all but impossible to buy a house or finance any other important project. For this reason and others, bankruptcy should always be considered a last resort.

Ultimately, the best way to deal with debt is to avoid it in the first place. Living by a budget is a surefire way to avoid debt. It is never too late to make a budget and it is especially important for those who have used debt consolidation, debt settlement, or bankruptcy to help their credit problems. Otherwise, old habits will repeat themselves and the mountain of debt will continue to grow.

• Annual Credit Report.com — site where U.S. citizens can request a free copy of their credit report from the three credit-reporting agencies once a year

• Approved Credit Counselors — U.S. Department of Justice searchable database of approved Credit Counseling Agencies

• Bankruptcy Law — Cornell Law School page on bankruptcy law in the United States

• Before You Apply for Personal Bankruptcy — U.S. Federal Trade Commission page on applying for bankruptcy

• Building a Better Credit Report — tips for improving a credit report and credit score

• Debt Consolidation — brief introduction to debt consolidation from the Alabama Cooperative Extension System

• Debt Management Guide — guide for managing debt written for college students but with helpful information for all adults

• Debt Repayment Strategies — ways to consolidate debt, listing the pros and cons of each strategy

• Debt Settlement — questions to ask before hiring a firm to work on your behalf for debt settlement

• More for Your Money — University of Illinois page on money management, including information on debt management

• Personal Budgeting — guide to creating a personal budget

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