What is debt consolidation?
Debt consolidation is a refinancing tactic in which someone takes out new loans to pay off her existing debt. The new loan combines existing debts to create one single large debt. Consolidated debt often has more favorable terms, including low interest rates and a lower monthly payment, but it usually comes with a longer repayment period.
A common form of debt consolidation is a debt consolidation loan, available from banks, credit unions and debt consolidation companies. These loans are specifically for borrowers who have difficulty managing their existing debts. Most of these are offered as a home equity line of credit (HELOC) using the borrower’s house as collateral.
Debt consolidation simplifies a borrower’s payments by grouping all payments into a single monthly one. Generally, that translates to lower monthly payments and longer repayment periods. Payments the borrower makes on the interest may even be tax-deductible if the debt is consolidated under a secured loan.
Sometimes, the bank or debt consolidation company will get borrowers lower interest rates than they were paying previously. However, because consolidated debt might take longer to pay off, it’s possible to pay more interest over the life of the loan. The borrower may also find that she’s unable to take out new lines of credit or use her credit cards until the debt is paid off.
If you’re struggling with bad credit but you need a personal loan, Bankrate can help you choose one that fits your needs.
Debt consolidation example
Carrie put seven thousand dollars’ worth of shoes on three credit cards. However, after she’s laid off from her columnist job at a weekly newspaper, she struggles to keep up with her monthly payments. She takes out a debt consolidation loan from a bank using her stake in a Hamptons timeshare as collateral. The bank pays off her existing debt and begins charging her a monthly payment against that payment plus interest. She’s better able to manage her debt, and, on tax day, she qualifies for a small refund against her interest payments.
Credit card debt consolidation example
Alternatively, Carrie accumulates her $7,000 total balance on a single credit card, which she transfers onto a balance transfer credit card with a 15 month zero percent interest introductory period. The card charges a fee of 3 percent of her balance, or $210. For the next 15 months, Carrie pays off her balance without accruing any additional interest at $467 each month plus the one-time $210 fee. At the end of the introductory period, Carrie is debt-free and can begin using her cards more responsibly.