Credit Consolidation
Debt consolidation entails taking out one loan to pay off many
others. This is often done to secure a lower interest rate,
secure a fixed interest rate or for the convenience of servicing
only one loan.
Debt consolidation can simply be from a number of unsecured
loans into another unsecured loan, but more often it involves a
secured loan against an asset that serves as collateral, most
commonly a house. In this case, a mortgage is secured against
the house. The collateralization of the loan allows a lower
interest rate than without it, because by collateralizing, the
asset owner agrees to allow the forced sale (foreclosure) of the
asset to pay back the loan. The risk to the lender is reduced so
the interest rate offered is lower.
Concerns of Consolidation
In recent years, reports in the media have raised concerns about
the use of consolidation loans. The worry is that many people
are tempted to consolidate unsecured debt into secured debt,
usually secured against their home. Although the monthly
payments can often be lower, the total amount repaid is often
significantly higher due to the long period of the loan. Debt
consolidation sometimes only treats the symptoms of debt and
does not address the root problem. In some circumstances,
snowballing debt may be a better solution.
There are other alternatives to a debt consolidation loan, where
unsecured debt is not "shifted" to secured debt, but is
eliminated through a settlement or payment plan. Debt
consolidation can be confusing for many people, so it is helpful
to learn about all of your options, and sometimes with the help
of an advisor.