Strategic Debt Management

Debt consolidation is a strategy for debt management that can have certain advantages in convenience as well as financial, turning the many payments you may be keeping track of into just one monthly payment, often lower than the total of the small payments. It is done by combining your small loans and debts into one larger loan, usually with a lower rate of interest and a longer term of repayment. There are a number of methods that can be used to consolidate debt, each with certain advantages and disadvantages according to your individual situation.

How Debt Consolidation is Done

There are many methods for debt consolidation. One method is to transfer high interest debt to a credit card with a lower interest rate. Most credit card companies will transfer balances when provided with the relevant information, such as the balance of the debt, the issuing bank, and account number. Often a credit card company will issue convenience checks that can be used to pay the debts, transferring the balance. This type of transaction usually carries a fee, and the lower interest rate may be limited to a certain time period, rising after that deadline has passed.

Another alternative for debt consolidation is a home equity loan. This option, offered by most banks and mortgage companies, is a loan against the equity you hold in your home. The amount of equity is determined by subtracting the mortgage debt owed on the home from its market value, the difference is the amount of equity you hold. Most lenders will extend a loan for up to eighty percent of your home equity. There is an application and approval process, as with any loan, with financial disclosure forms to prove ability to make payments, and a home appraisal done to determine the level of equity. Comparison-shopping is the key with these loans, as terms and interest rates are variable according to which lender you choose.

There are loans available that are meant for debt consolidation specifically. These also require a typical loan application process with financial information provided to show the ability to meet a monthly payment. The interest rates on these loans are often higher than those offered for home equity loans and collateral may be required for larger loan amounts.

Benefits of Consolidating Your Debt

One benefit offered by debt consolidation is the convenience of making just one monthly payment, rather than a variety of smaller payments, all with different due dates to keep track of during the month. Another advantage often realized with consolidation is a savings on interest rates, as consolidation loans often offer a lower rate than the smaller debts they replace. Monthly payments on a consolidation loan are often less than the total of all those smaller debts, giving additional financial benefit.

Drawbacks of Consolidating Your Debt

There are disadvantages to debt consolidation that should be considered carefully, in order to make a well-informed decision on how to best handle your personal debt situation. If you are considering a home equity loan, this type of loan is secured by a lien on your home. If you default on your loan agreement, the lender can foreclose on your home to recover the debt owed to them. Before using a home equity loan for debt consolidation, you would be wise to be make sure that you are very confident in your ability to meet the monthly payments over the term of the loan. Another consideration is the term of your consolidation loan. If your consolidation loan has a longer-term than the existing smaller loans it will replace, you may pay more in interest over the term of the loan, even with a lower interest rate. This may leave you without any real savings over the long run, even though the monthly payment may be smaller. A longer-term consolidation loan will also extend the amount of time it will take to pay off the debt.

Is Consolidation Right For You?

In order for debt consolidation to be to your advantage, the monthly payment on your consolidation loan should be lower than the total paid on the individual loans every month. The interest rate and length of the consolidation loan are important to consider as well. If the interest rate on the new loan is less than the average rate paid on the smaller ones, you can save on interest costs. The term of the loan will have an impact on the total interest paid, so if you use a consolidation loan with a longer term it is wise to calculate the total cost of the loan, to determine if the length of the loan is likely to eliminate the saving realized by the lower interest rate and smaller monthly payment.