Debt consolidation is a popular option used by regular people and investors. Essentially, you take out one loan to pay off many others. The main advantages and reasons to do this are that you can obtain a lower interest rate, obtain a fixed interest rate or just simply for the convenience of only having one loan to deal with.
There are other ways to consolidate your debts — for example, if you have an unsecured loan with a very high interest rate, you may be able to consolidate it by adding some sort of collateral as backing for your loan (a house or a car). If this is done, then the loan becomes secured and often a much lower interest rate can be negotiated as well.
Another common term for debt consolidation, which is used in some parts of the world, is debt settlement. However, this term can also be a more general term that is used when the debtor and creditor agree on a reduced balance that will be regarded as having been paid in full. The term settlement is also used in resolving legal disputes, many of which involve contracts, debt and creditors.
Buyer Beware! — Debt consolidation can be tricky
Some economists argue that debt consolidation can be a huge danger for people who are already in a lot of trouble with debt. The danger comes from assuming that by consolidating all your debts, you have effectively solved the problem. This is not the case though. The danger with debt consolidation comes from the fact that you are usually putting up something that is much more valuable as collateral to secure a lower interest rate. You might have effectively put all your debts into one handy payment to the bank on a monthly basis, but on the other hand, if the bank decides that they want to collect on the consolidated loan at any point you could be losing your car, or even worse, your house.
Another problem that many clients do not realize when it comes to debt consolidation is that you have to be careful about the contract you are signing. While you may have lower monthly payments, and the interest rate may be lower overall, pay careful attention to the length of the contract. Often the debt consolidation term is a lot longer than the original debts! This essentially means that you are paying more in the long run. It’s normal for a company offering debt consolidation services to make a profit (otherwise they would not do it), but don’t get yourself ripped off in the process!
Recommendations for managing debt
Debt is sometimes thought of as a problem, but it can more correctly be understood as a symptom of a larger problem — overspending and under saving. While there is certainly no harm (and in fact in many cases it is even beneficial for your credit rating) to take out small loans that you intend to pay back within a reasonable time such as a month or two (this is usually done with a credit card, to build credit ranking), the real problems start when confident users of credit begin to increase the amount of money they are borrowing beyond their monthly means.
A proper balanced budget, which everyone should undertake to create every month for their income and expenses, will take into account necessary payments (rent, utilities, food, etc.), debt payments (mortgage, credit card bills), income (full or part time work, freelance, business income) and of course savings.
How to beat debt consolidation with savings
Savings are the best way to beat debt consolidation problems. All it takes is to put a little money aside every time you get some income. There are a number of ways you can save. The most popular is to open a high interest rate savings account at your bank or another bank. The restriction is that you can put money in very easily, but if you take money out it comes with fees or you can lose your interest if it happens before a certain pre-agreed time.
It has been noted that those who need to consolidate their debts are also highly likely to allow that debt to grow back. The reason for this is simple. The spending patterns that got them into that debt in the first place have not changed. The interest you have to pay means you end up paying more over the long term and it’s also common that people with debt consolidation issues do not have savings set aside for “unexpected events”, which always come up.
Some situations where debt consolidation can really help
Debt consolidation is still helpful in a one off manner. For instance, if you do not have any emergency savings and suddenly need to spend a few thousand dollars on medical expenses, and you cannot borrow money from a friend or family member, then debt consolidation can help you as a last resort option.