More than likely, you're probably already familiar with debt consolidation. A few years ago, almost everyone with any equity in their home was being talked into a consolidation loan.
Unfortunately, many of them are now facing foreclosure or underwater (i.e. their mortgage balance is greater than the value of their home).
So, before you consider a consolidation loan as your debt solution lets discuss exactly what it is, how it works and what you should be aware of:
What is debt consolidation?
Simply put, it's taking out a larger loan to pay off several smaller loans.
For example, lets say you had an auto loan, credit cards, and a student loan that totaled about $30,000; and you decided to take out a home mortgageloan for $30,000 to pay them off. You basically consolidate the balances of the three loans into one loan.
Why would I want to consolidate my debt?
A consolidation loan can be used as a way to restructure your debt to lower your monthly debt payments. By paying off your higher interest rate debts with a single lower interest rate loan and extending the payment term, your monthly payments can be reduced.
For example, if the total of your auto loan, credit cards, and student loan payments is $1,500 per month and you consolidate your loans into one mortgage payment for 30 years at a lower interest rate, your new debt payments could be lowered to around $250 per month (depending upon your new interest rate).
A loan consolidation doesn't eliminate your debt. You would still owe the full $30,000 but your monthly payment would be lower.
There is definitely a benefit to using a consolidation loan as your debt solution, assuming it is a part of your overall debt elimination plan.
Here's where you can use your credit scores to your advantage. Lets assume you improve your credit and your credit scores increase. This would qualify you for a lower interest rate loan.
If you then get a consolidation loan and free up money to make extra monthly principal payments on any remaining debt (including your new debt consolidation loan), it can be an effective tool to help you to get out of debt faster.
Unfortunately, you may be tempted to just incur more debt after the consolidation. You may be tempted to use the extra money to buy a new car or even run up the balance on your credit cards again. This is why you have to be verty careful if you decide to use this as a part of your debt solution.
If you decide to use a consolidation loan as a part of your debt solution, remember the key is to make sure you only consolidate loans with higher interest rates into a lower rate consolidation loan.
And make sure you use it as a part of your overall debt elimination plan.
I repeat: whatever you do, do not incur more debt after the consolidation! Use it only as a debt elimination strategy. Don't fall for the trap of incurring more debt.