For anyone struggling with debt, consolidation appears to be an attractive proposition. Debt consolidation replaces existing loans and debts with a single loan, leaving just one payment to make each month. Whilst borrowing more money to get out of debt does not sound like a logical solution, debt consolidation can sometimes prove surprisingly economical over the long term.
Unsecured borrowing attracts high interest rates. For most people, the majority of the repayments made on existing loans barely cover the interest. Meanwhile, very little is going toward reducing the actual debt. When finances get tight, it is natural to try to minimize outgoings as much as possible. Often, one of the first things people do is cut the repayments on credit card and store card debt to the minimum. Unfortunately, the majority of the payment will be put toward the interest, with very little actually going to reduce the debt. Credit card companies love people who only pay the minimum each month, as they will stay in debt longer and the company will make more money.
Debt consolidation helps to break the cycle of spiraling interest charges, by replacing all existing unsecured borrowings with a new loan, often at much lower rates. The loan repayments will be spread over a longer time period, but in many cases the total repayable will be lower than if the existing loans were left to run.
The downside to debt consolidation is that it extends the period a person remains in debt. Neither is it guaranteed to be a more economical solution in some cases. Debt consolidation works best for people with a reasonably high level of unsecured debt, including credit or store card debt, which is not likely to be cleared in the near future. If loans are due to be settled within the next few years, or attract a preferential rate of interest, it is unlikely that debt consolidation will offer much benefit.
For many people, the attraction of consolidation is the reduction in monthly outgoings. In some cases, repayments can be reduced by up to two thirds. Of course, this must be offset against the extended period of the loan, but it may be that with the financial burden lifted, additional funds can be used to pay off the consolidation loan more quickly.
One often overlooked benefit of debt consolidation is the positive effect it has on credit rating. When applying for any form of credit, one of the factors that a lender considers when deciding whether to lend, is the level of existing commitments. Existing debts and loans are marked as settled, and lenders can see only one major outgoing as opposed to several. The better the credit rating, the easier and cheaper it will be to borrow money in the future.
Debt consolidation is a major financial decision, and as such it is always wise to seek advice from a qualified debt counselor or financial advisor. Whilst this article covers the basic advantages and disadvantages of debt consolidation, it is no substitute for proper professional advice.