Debt consolidation means taking a loan to close off the majority of the other debts. This is usually done to avail a lower rate of interest, reducing the monthly payments and also to secure a fixed interest rate. This is generally a risk free program which involves a third party to negotiate on your behalf with your creditors. In many cases, one single debt consolidation makes monthly payments to all your money lenders and makes you completely debt free.

There is an agreement that is worked out with all your creditors based on what you can afford to pay. There have been instances when interest rates and payment amounts are reduced allowing you to come out of the financial obligation much faster and with less amount of money. Though this loan type is pretty lucrative and generally risk free, it is better to take some cautions.

To start with, be careful of the type of loan that you are choosing. Think and decide properly before consolidating unsecured debt to a loan secured by your house; remember, if you make any wrong calculations, you can end up losing your home. Moreover, thoroughly scrutinize the terms and conditions of any consolidating loan that has a variable rate of interest.

Finally, studies have revealed that rolling all your debts into another loan can backfire on the customer. There is a possibility that within one year the consumer will again increase his debt by utilizing the same credit cards which were paid off in the consolidation loan – thus making him pay not only on the credit cards once again but also on the consolidation loan.

Loan consolidation for students

Federal student loans are consolidated in a little different manner in the United States as the federal student loans are granted by the government. In a federal student loan consolidation, all the open loans are closed off by the Department of Education or a loan consolidation company. The interest rates (for the consolidation) are dependent on the on that particular year’s student loan rate that in turn is based on the 91-day Treasury bill rate at the last auction which is held in the month of May of each calendar year.

Often federal student loan consolidation is mistakenly referred to as refinancing; for it must be remembered that these rates are not changed but just locked in. In contrast to debt consolidation in private sectors, student loans do not incur any fees for the borrower.

The apprehensions about consolidation

In the recent years, a lot of questions have been raised about the use of such consolidation loans. As discussed earlier, many consumers try and consolidate all unsecured debts into a secured debt, where the house is used as a guarantor. Though, there is a considerable reduction in the total monthly payment, you can see that the total amount repaid is often much higher due to the long tenure of the loan. So, in some situations, snowballing debt is a better solution.

There can be other alternatives to a debt consolidation loan where the unsecured debts are not shifted to the secured debt but removed either through settlements or through a payment plan. Debt consolidation can create confusion amongst users, so it is advisable to seek professional help and clarify all doubts.

Some FAQs about debt consolidation

How will I qualify?

You be qualified to avail this loan if you have unsecured loans like credit cards, personal loans, utility bills and medical bills and wish to correct your finances by closing them.

How much will I actually save if I take this loan?

Most of the credit counseling agencies can assist you to bring down your monthly payments significantly. A consumer who has a debt of $15,000 on his credit cards and is paying an interest of almost 21% will see the following changes from a debt consolidation program:

The existing finance charge – $15,375
Program finance charge – $6000
The present rate of interest – 21%
The new rate of interest – approximately 9%
Time to pay off debt from the current plan – 81 months
Time to pay off debt from the new plan – 56 months
Total savings – $9,375
Time savings – 25 months