What Debt Consolidation Is and Is Not

Debt consolidation sounds like one of those things that you sort of understand. But when you really ask people about debt consolidation, sometimes they get it mixed up with debt relief or bankruptcy or other financial plans to deal with excessive indebtedness.

Debt consolidation is actually a debt. It involves rolling together (consolidating) your smaller debts into one large debt.

For instance, let’s say you owe $20,000 on six different credit cards, plus you have $12,000 more to pay on two car notes. The debt consolidatiuon approach would take out a loan of $32,000 to pay those debts off. So far, so good. (That’s why debt consolidation can, in some cases and used properly, actually improve your credit rating.)

The problem is that now you have one giant debt of $32,000. In a way, you didn’t really gain anything, you just re-structured your debt.

But the re-structuring can be a smart financial move. If you do it correctly, you can often get a lower interest rate on the large debt than you previously had on your string of smaller debts. This is particularly true if you had a lot of in-store loans (for electronics, furniture) or department store credit cards. This means your monthly payment on the $32,000 should be lower than the sum of your smaller payments.

The single payment is also simpler. You’re much less likely to get hit with late fees or wind up robbing Peter to pay Paul as you juggle minimums on many different loans. In the world of finance, simpler is often better.

Debt settlement, debt relief, and debt negotiation are plans that involve going to your creditors and trying to negotiate a lower payment of some sort. These approaches have their merits in some situations, but they almost always hurt your credit score and they can be risky. Check out debt conslidation first; these other plans should be more like backup in case you can’t make debt consolidation work for you.

Bankruptcy is a last resort. That’s not to say it doesn’t have its place, and there are people who need to use it. But bankruptcy not only messes up your credit (for seven years), it takes away a lot of your financial freedom, not to mention decreases your financial self-confidence.

Debt consolidation is a very moderate approach. In fact, many businesses restructure loans all of the time since it’s just financial common sense in some situations.