Debt consolidation is the process of merging all your unsecured debts into one monthly payment.
How it’s done
Debt consolidation can be done by taking out a debt consolidation loan from a bank, or by using a home equity loan. Debt is usually consolidated with a loan, which is used to clear all your debts. You then pay off the new loan instead of sending individual payments to all your creditors.
Consolidating with a home equity loan is risky as your unsecured debt becomes secured with your home as collateral. If you default on payments, your home could be foreclosed. This would not be the case had your debts remained divided.
You could also hire a debt consolidation company. However, in this case, your debt may not be consolidated with a loan—your payment may be consolidated, but your debts would remain individual. If this is done, you would send a monthly payment to the debt consolidation company, which would then divide the payments and send them to all the respective creditors.
Advantages and disadvantages
Debt consolidation is a good option only if it lowers your interest rate or monthly payment, or both. This makes your monthly loan payment much affordable but often results in the lengthening of your repayment period. This means you would have to pay off your debt for a longer time than if you hadn’t consolidated it. Additionally, the total interest on your debt also increases due to the extension of the repayment period.
What to remember
Consolidating your debt may make you feel like a burden has been lifted off your shoulders. However, the reality is that your debt remains the same. Instead of making multiple monthly payments, you would now only make a single payment. This does not change the total amount of debt, it only makes managing your payments easier.
Alternatives to debt consolidation
You can consider some alternatives to debt consolidation to repay your loan sooner while saving money. One such alternative is paying your debt on your own. Although it may be more difficult, you can create a plan to clear off one debt at a time. Choose a debt on which you will focus a larger payment, and pay the minimum on others. Once you clear the account, move to the others, and follow the same strategy until all the debts are paid off.