Debt consolidation businesses are booming as many people struggle under the weight of big debt. Choosing to consolidate your debt can seem like an easy solution if you can save monthly expenses. But is debt consolidation a good thing? For some, yes. For many, it may not be the answer you need to save money on your bills. Learn how debt consolidation works so you can decide if it's good for you.
Function
The function of debt consolidation for credit card debt, according to many who offer the service, is to bring your monthly debt payments down by combining all of your bills into one. The payments are made to the consolidation service and not any of the original creditors. The service would charge you a fee that can either be a flat rate or a percentage of the original balance per creditor. In exchange, the consolidation service negotiates a lower percentage rate for each creditor. If the consolidation is a loan, the consolidation service can offer to settle the accounts for a lower amount. To consolidate mortgage debt, debt consolidation companies would assume the mortgage at a lower interest rate with the home serving as collateral.
Time Frame
It can take less than three days for debt consolidators to negotiate new terms with each creditor, should the creditors accept the program. Consumers would most likely have to authorize the consolidation service to draft the payments straight from their checking accounts. Once the terms are agreed upon, consolidation loans can take anywhere from a few months to several years for a payoff.
Benefits
One major benefit if debt consolidation is that you can pay off several high-interest credit cards at a significantly lower interest rate. Lower interest rates means less time it should take to pay off the accounts. Also, debt consolidation allows you to pay just one bill instead of several creditors that require payments at various times of the month. With debt consolidation, you pay once a month to one service. For home equity consolidation loans, there is a possibility of a tax deduction because of what you pay in mortgage interest rates.
Considerations
Debt consolidators often do not work for free. Many ask for long-term payoffs that, at first, seem reasonably lower but cost you more in the end. For example, let's say your debt is $10,000 at an average of 20 percent APR that would take 5 years to pay off at $200 per month. If the consolidation loan gets your payments down to $100 a month, you would still be paying for the same debt for 10 years, plus whatever fees the consolidation company charges. If you never reach a point where you can put some of that saved money towards the debt, you stay in debt longer. Your creditors do not always list your accounts as paid in full by the consumer. They can be listed as debt management, charge-offs, closed by creditor...you name it. Even if you've never missed a payment, having these labels attached to your credit report may turn off future lenders.
Prevention/Solution
One solution is to transfer balances of credit cards into a lower-interest card. You may still end up paying the same amount each month on your credit card bills, but you still have the benefit of making one payment. You will also pay off the total debt faster since the interest rate is lower. Another way to avoid debt consolidation for credit cards is to refinance other loans you have, such as automobile loans. If you can shave off 3 percent of your loan's percentage rate, take the savings and pay on your credit card. You may end up extending the loan of your vehicle, but at least you have something to show for it on a 7 percent APR vehicle versus a 19 percent credit card.
