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Everything You Need to Know About Debt Consolidation Loans

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Debt consolidation programs can provide borrowers an alternative to bankruptcy with less of a long-term effect on their credit. Here we take a look at some of the basic features of debt consolidation.

What Are Debt Consolidation Programs?

A debt consolidation program is a financial restructuring in which a borrower pays off many debts either by taking out a new loan or entering a third-party debt settlement program, effectively combining multiple debts into a single payment. 

A debt consolidation company can be a company that originates debt consolidation loans or a third-party agency that offers debt settlement or credit counseling services. A debt consolidation loan is generally more appropriate for a consumer who wants to simplify their multiple loan or credit card payments but has the capability to repay their debts in full. Credit counseling, debt relief or debt settlement tends to suit people who find themselves unable to repay their debts as they originally agreed to.

Is Debt Consolidation a Good Idea?

If you’re looking for a debt consolidation loan, rather than going through a debt consolidation program, the process is much like getting any other loan: You will have to meet a lender’s credit and debt-to-income ratio, otherwise you won’t qualify. You’ll want to do some math before deciding to apply for a debt consolidation loan: If you can’t get an interest rate that’s lower than the aggregate interest rates on the debts you plan to consolidate, a consolidation loan may end up costing you more than repaying the debts separately. A consolidation loan also confines you to a fixed repayment term and, potentially, a fixed monthly payment. While that’s good for setting a firm timeline for getting out of debt, you also want to make sure you’re not committing to more than you can afford.

The qualifications for a debt consolidation program or credit counseling are similar to those of bankruptcy. Many people who may believe that their only option is bankruptcy actually qualify for a consolidation program. Contrary to popular belief, a consolidation loan does not automatically destroy long-term credit. But because you may not be repaying your debts as originally agreed, your credit may suffer as a result of a debt consolidation or credit counseling program. In certain situations, it may improve the borrower’s credit score over time, because making on-time payments on your debt consolidation program can improve your payment history, a crucial component of a good credit score.

Debt consolidation loans may also have an improved interest rate and a lower monthly payment when the former loans are aggregated. The result for the borrower may be less principal and total interest paid over the life of the loan.

Debt consolidation also reduces the number of collectors that a borrower owes money to, because payment is made to one entity. There is less of a chance that payments will get lost in transit, and there is less pressure to pay from only one creditor.

What Is Credit Card Consolidation?

Credit card consolidation is the practice of combining all of the balances from multiple credit lines into a single payment. This type of consolidation is a specific type of debt consolidation loan that focuses on credit cards specifically. However, credit card consolidation can also be managed through a third-party company.

As an alternative to a consolidation loan, you can consider a balance transfer credit card. Many credit cards offer introductory 0% annual percentage rate (APR) periods (generally between 6 and 18 months), allowing you to save money on interest while you chip away at your balance. Again, it’s important to do the math and make sure your potential savings outweigh any balance transfer fees. It’s also important to plan to repay the debt before the end of the 0% APR period.

How Does a Debt Consolidation Loan Work?

For people considering a debt consolidation loan, there are two types: unsecured loans and secured loans.

A secured loan is a consolidation vehicle that is tied to a large asset of the borrower. In most cases, this asset is either a house or a car, although the asset can also be a boat or a valuable piece of artwork. If the borrower defaults on the loan, he or she relinquishes ownership of the asset that is tied to the loan.

An unsecured debt consolidation loan is not tied to an asset. Rather, the terms of the loan are based on the credit history of the borrower.

While a secured loan may be easier to obtain, it has serious risks. If you can’t afford your payments, not only do you suffer credit and financial consequences of defaulting on the loan, you can also lose your property. That may put you in a worse situation than you were in before consolidating your debt.

Before you take out a consolidation loan, be sure you’re comfortable with the interest rate, repayment period and any other terms.

How Does a Debt Consolidation Program Work?

If you find yourself overwhelmed by your debts and think a debt consolidation program might be right for you, take the time to research third-party organizations. Search company names on the Better Business Bureau or Consumer Financial Protection Bureau websites, and ask companies about any fees you may incur by using their services. Watch out for debt consolidation companies charging hefty, upfront fees or making too-good-to-be-true promises, and if a company can’t answer your questions, you may want to explore other options.

Once you enter a credit counseling or debt consolidation program, you’ll likely have to take a break from using credit until you’ve completed the process. (This may require closing credit accounts, which can have a negative effect on your credit.) Your only debt payments will go through the third-party company, and once you’ve completed the program, the company you’re working with may be able to help you re-establish or rebuild your credit. Keep in mind that settling a debt for less than you originally owed may have tax consequences, as well, because the IRS considered canceled debt a form of taxable income. (You can read more about 1099-Cs and canceled debt here.)

As you work to pay down your debt and rebuild your credit, you can track your progress by reviewing a free snapshot of your credit report on It’s also a good idea to review your free annual credit reports to be sure your debt consolidation efforts have been correctly reported to the major credit reporting agencies.

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