How Does Debt Consolidation Works?

BankruptcyNot all people can afford to pay their debts. This is one of the reasons why a lot of people look for different debt management strategies to organize their debts. Some go with budgeting, credit counseling, debt settlement, and other debt relief services, file for bankruptcy, or go with consolidation. Most of the time, the last two options are two of the best strategies to have. But let us focus on debt consolidation. Who is it for and how does debt consolidation work?

What exactly is debt consolidation?

With debt consolidation, all your debts would be rolled into one – or consolidated, as the name implies – so you do not have to worry about too many creditors and too many accounts to keep track on at the same time. The more the creditors you have to deal with, the more stressful the process of managing your debt becomes.

Enter in debt consolidation. A lot of people find managing their debts much easier when they only have to deal with one debt instead of too many different ones each month. Another advantage that debt consolidation offers aside from making too many debts into just one is that a debtor has a high chance of getting lower interest rates for the debts and be granted lower monthly repayment scheme. In simple words, debt consolidation helps debtor save money and protect their credit ratings in a way. Read how debt consolidation can be beneficial in managing debts and why debtors should consider it.

Advantages of Debt Consolidation

Credit ratings and reputation

Compared to bankruptcy, debtors who go for debt consolidation do not have to worry about public records of their credits. People who are very interested in a debtor’s credit rating can easily find a bankruptcy case filed when they look hard enough since bankruptcy records are often public and are made viewable especially with PACER, an electronic subscription service as well as federal bankruptcy courthouses. In a bankruptcy case, a debtor’s credit rating and reputation is already tainted with the bankruptcy and it automatically lowers a debtor’s credit score. On the other hand, debt consolidation can also appear in a debtor’s financial report but it does not necessarily affect or lower a debtor’s credit score.

Maintained credit access

In debt consolidation, a debtor is given the privilege to maintain his/her credit cards unless it is stated otherwise in the debt consolidation agreement. Given this, a debtor may still use their credit cards especially if an emergency happens. However, a debtor should also take note that an in default cases or owing a lot of money might also cause them to not be able to use the credit card or be granted any additional credit. Also, the continuous use of a credit card defeats the main purpose of debt consolidation which is to be free of debt over a period of time.

Simplified debt management

Different debts can be treated differently. These differences might also call for different debt management strategies. However, the strain of managing too many debts at ones can be overwhelming. It might also be hard to keep up with payments on time due to the differences of rates, creditors, and payment schedules to follow. With the help of debt consolidation, all a debtor has to do is to make one payment for all which is way more convenient and provides a simpler form of debt management.

Lower monthly payments and interest rates

Another advantage of debt consolidation is that it affords the debtor lower interest rates that are more manageable to pay every month. For example, a debtor might incur a debt from three credit cards with three different interest rates of 12%, 15%, and 18% respectively. By consolidating the debts, the resulting debt can come up with a rate of 10-15% combined which allows the debtor to save a lot of money on monthly payments. Also, there will be just one payment to be made in a month so the debtor will have more cash available to meet their basic needs.

Is there a downside to debt consolidation?

Just like any other debt management schemes, debt consolidation does not just come with advantages. There are also several downsides that debtors have to be aware too. These are:

Losing property

Under debt consolidation, home or vehicles can be used as collateral which a debtor can lose once s/he defaults on the scheduled debt payments. There is also the matter of cross-collateralization wherein a credit union can repossess a debtor’s property that it has financed on the condition that the debtor defaults on the agreed debt consolidation payments.

Hidden charges

The idea of lower monthly payments and debt interests sounds very appealing but there are hidden charges that might be involved when a debtor chooses to consolidate his/her debts.

Tax consequences

Debt consolidation is also considered as a debt relief since it helps a debtor save money. This money is in turn considered by the IRS as income. In other words, a debtor would have to pay taxes on the money they saved out of debt consolidation.

Longer payment period

Another drawback of debt consolidation is the long payment period. In bankruptcy, it takes a debtor about 3-5 years to settle their debts through a repayment plan. In debt consolidation, the process might take even longer because lower monthly payments only mean paying in the long run to be able to pay the agreed interest rates.

Who provides debt consolidation?

Since most debts involve in debt consolidation are composed of student loans and credit card debts, those who provide debt consolidation are credit card companies, credit counseling companies, debt management companies, banks, mortgage lenders, and peer-to-peer lenders.

Is debt consolidation the best debt management strategy to use?

Depending on a debtor’s situation, debt consolidation can be a very good option especially if a debtor happens to deal with multiple debts at the same time with high interest rates and needs the benefit of a lower interest rate to be able to pay their debts on schedule.

Free Bankruptcy Lawyers