Debt consolidation refers to the process of taking out a loan to repay a set of other loans, liabilities and debts. The aim is to combine multiple debts into a single, large, loan that has more attractive interest and payment terms; that is, a lower interest rate and/or a lower monthly payment. The idea is to deal with multiple debts, such as student loans and outstanding credit card amounts, in a single obligation that has more attractive repayment terms. Most loans, for example, will have lower interest charges than credit cards and also offer a fixed repayment schedule.
Most people apply for these types of loans through their bank, credit union or credit card company because they have an established relationship with these institutions and a history of making repayments. There are also private lenders and mortgage companies that offer these types of loans. Creditors are willing to provide these types of loans because it increases the chances of recovering their money from a debtor. It is important to remember that these types of loans do not erase the original debt, it is simply being repaid in a different way where the person’s loans and obligations are being combined into one obligation that is transferred to a different lender.
Debt consolidation loans are generally one of two types: secured and unsecured. Secured loans are guaranteed against assets (such as a house) which acts as collateral for the loan. Unsecured loans are not backed by any collateral and can be more difficult to obtain, have higher interest rates and have more stringent acceptance conditions.
There are some important things to consider before undergoing a debt consolidation process. A debtor should ensure that the overall interest they will be paying on the consolidated loan is actually less than they are paying currently. The interest rate set by the lender can be conditional on a credit score or be set at the discretion of the lender. In addition, low interest rates that are offered initially for the loan can change in the future; this sometimes applies to consolidating credit card balances where an attractive rate may be subject to change after an introductory period.
The most important element of debt consolidation for many consumers is an attempt to change their habits with money and credit. They need to remember that consolidation often means that they will owe the debt for a longer period and if they continue to use credit in other areas they will not achieve their aim of becoming debt-free.
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