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[caption id="attachment_21492" align="aligncenter" width="518"] Like debt consolidation, the Three Musketeers were "one for all."[/caption]
What's worse than having one overloaded credit card? Easy: having more than one overloaded credit card and falling behind on your payments.
If you've ever been in this situation, then you know that it's easier than you'd think to lose track of your minimum monthly payments and find yourself in hot water with your creditors. On one hand, you're paying a huge chunk of your income each month just to keep your creditors off your back. On the other hand, you're juggling multiple due dates and varying payment amounts for a variety of different debts. Eventually, almost everybody slips up and misses a payment here or there.
In situations like this, debt consolidation loans come in handy. Instead of having to deal with all of these different payments each month, you only have to deal with one. Instead of many debt payments, it's one for all.
However, what exactly does a debt consolidation entail? What are the pros and cons? How do you know if debt consolidation is right for you? While there aren't simple, easy answers to these questions, you can follow some guidelines to make the right decision.
What exactly is debt consolidation?
In simplest terms, debt consolidation is the process of taking all your various debts and combining them into a single payment that's easier to manage. Of course, as is usually the case when it comes to financial decisions, there's a lot more to it than that.
First, there are several different types of debt consolidation to consider, and each has a set of pros and cons.
Different types of debt consolidation
While there are many different services out there billed as debt consolidation, there are a few that are easily the most popular: debt consolidation loans, balance transfer credit cards, and debt settlement.Debt Consolidation Loans
Debt consolidation loans are easily the most popular form of debt consolidation. With a debt consolidation loan, you work with a lender to take out a personal loan equal to the amount of the debt that you'd like to pay off. Then, you use that loan to pay off your debts. In the best situations, you end up making a single monthly payment that's lower than what you were paying before to get out of debt sooner than you would otherwise.
Debt consolidation loans come in all types, shapes, and sizes. Most often, people make a distinction between secured and unsecured debt consolidation loans. While both loan types sound similar, they're actually wildly different in practice.
With an unsecured debt consolidation loan, the lender offers you the loan based on your creditworthiness alone. It looks at your financial history and other factors and determines that you're a "safe" investment in the sense that it can trust you to keep up with your payments for the duration of the loan. In return for the loan approval, all the lender really asks for is your signature and your promise to pay the loan back in full.
With a secured debt consolidation loan, the lender offers you the loan only if you are able to put up some form of collateral to back it up. Collateral can be any major asset, but in the case of debt consolidation, it's usually something like your car or home. If you can't keep up with your payments, then the lender can legally seize and resell that collateral to make some of its money back.
Secured loans often have lower interest rates and more favorable terms than unsecured loans do since the lender is taking on less risk. They're also often more accessible than unsecured loans for individuals with bad credit. That said, they're not the perfect deal, per se; after all, with a secured loan, you're putting yourself at risk of losing your car, home, or other major asset.
The debt consolidation loan is what most people think of when they think of debt consolidation, and it's probably the simplest debt consolidation method to understand. It's just not the only one.Balance transfer credit cards
Opening up a new credit card to get out of credit card debt seems deeply counterintuitive. However, the balance transfer credit card has been a wise debt consolidation method for many debtors.
With a balance transfer credit card, you open up a new credit card with a high limit and a 0% introductory APR offer attached to it. That means that, for a limited time, that new card won't accrue interest.
Once approved for the card, you use it to pay off all your other credit cards at once. Then, you put all your financial muscle into paying off the balance on the new card before it starts to accrue interest.
In a way, balance transfer credit cards don't just help to consolidate your debt; they halt the accrual of interest so that every dollar you pay during the introductory promotional period goes towards eliminating your debt, not just staving off interest.Debt settlement
Debt settlement is a third popular method often framed as a form of debt consolidation. With debt settlement, you work with a third-party company whose main purpose is to negotiate with your creditors. Generally, you'll stop making payments to your creditors and start paying into a savings account managed by the debt settlement company. As you might imagine, your creditors won't be too happy about this, but often, the debt settlement company will step in and act as a buffer, absorbing the harassment you would normally receive from debt collectors.
After a period, you'll have amassed quite a bit of money in your savings account. At that point, your debt settlement company will take that money and approach your creditors with an offer: accept the lump sum payment and forgive the rest of your debt. Often, your creditors will take the deal, since certain money now is much more attractive to them than uncertain money later.
While debt settlement isn't the most common or well-known form of debt consolidation, it achieves similar results: a single monthly payment and the ability to become debt free much sooner than you would otherwise.
Now that you understand the major forms of debt consolidation, you should learn the pros and cons of debt consolidation to get a feel for if it's right for you.
The pros and cons of debt consolidation
On paper, debt consolidation can seem like a no-brainer when you're in a significant amount of debt to multiple different creditors. However, like any other financial decision, it has its fair share of pros and cons to consider.
Pros of debt consolidation
The upsides of debt consolidation can make a huge difference for someone who is struggling to keep up with debt. The two major pros are reduced stress and lower payments overall.Reduced stress
The main thing that tends to attract people to consolidation is the prospect of reduced stress through a single consolidated payment.
If that doesn't seem like a huge draw to you, think through the following scenario. Somehow, you've run up high balances on a variety of different credit cards. Maybe this happened through no fault of your own. You had a sudden medical emergency in your family, for instance, and you needed to rely heavily on credit to make ends meet. Maybe this happened because you were living outside of your means. You kept treating yourself to new luxury purchases, clothing, gadgets, and expensive nights out, financing it all with the credit cards you only opened to pay for emergencies. All of a sudden, you're swimming in debt.
Whatever led to your indebtedness, the result is the same. A huge chunk of your income is going towards keeping up with monthly minimum payments to a wide variety of different creditors. These payments fall on different days of the month in different amounts with different interest rates and different anticipated payoff dates. You can barely keep track of what you owe and to whom you owe it, much less come up with a plan for getting out of debt. You start to feel overwhelmed and hopeless.
In this case, consolidating your debt into a single payment can be an enormous pro. You only have to make one payment a month and keep track of one total balance, reducing the stress of being in debt.Lower short-term and long-term payments
Even more than reduced stress, paying less on your debt can be a huge draw for someone considering debt consolidation. This kind of money saving isn't guaranteed with debt consolidation, but it is the ideal scenario.
In the short term, you save by reducing your overall monthly payment. Of course, your debt consolidation payment is probably going to be more than any single one of your former minimum monthly payments. However, it will likely be less than the sum total of all of your separate monthly payments.
In the long term, you save by reducing the amount you pay overall in interest. This savings will change depending on numerous things (especially the consolidation method that you choose), but it is common. Few forms of debt have higher interest rates than your run-of-the-mill credit cards.
Cons of debt consolidation
Consolidation can sound like an easy fix to your debt problems, but it has its fair share of downsides, too. It's not always easy to get; it can be risky; and it fixes the symptoms of your debt issues, not the causes.Debt consolidation can be hard to get with bad credit
It's funny: people with bad credit are often the people who need consolidation the most. However, they usually have the hardest time finding it.
That's because the most common forms of debt consolidation, such as personal loans and balance transfer credit cards, actually involve borrowing more money at the outset to pay down your debts. To borrow money, you need to work with a lender. Lenders like to see good credit when assessing whether to lend to you; after all, bad credit indicates that you've struggled to pay back your lenders in the past.
There are plenty of debt consolidation options out there for individuals with bad credit, thankfully. If that's you, be careful. While there are many reputable companies that will be willing to work with you, there are also disreputable companies out there that take advantage of individuals without options. Be wary.With a secured loan, debt consolidation can be risky
If you do have bad credit and manage to get a debt consolidation loan, chances are high that it will be a secured loan. This might work out well for you, but you'll need to be careful. If you fall behind on your debt consolidation loan, you could be in a world of trouble.
Maybe something unexpected happens. You lose your job; all of a sudden, you're missing payment after payment. Eventually, your lender says enough is enough and seizes your car or your home. You're much worse off than you were before.
That's not to say you should never take on a secured loan, of course. It's just risky.Debt consolidation fixes the symptoms of debt, not the causes
People tend to think of debt consolidation as the solution to their debt problems, but that's not the case. Debt consolidation gives you room to breathe and a chance to get out of debt faster, but it doesn't eliminate the reasons why you got into debt in the first place.
Say you fell into debt because you lacked financial discipline and were living outside of your means. A debt consolidation loan might make your existing debt easier to handle, but it won't stop you from falling into old habits. If you can't control your spending, you'll end up worse off than you were before.