First Person: What Is Debt Consolidation?

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Debt consolidation, in its most basic form, is the consolation of two or more debts into one monthly bill, and this can be performed in several ways. A debt negotiation and consolidation can be setup with a debt consolidation company. A secured or unsecured loan can be applied for and received to cover all the debts, or debts can be rolled into a second mortgage that uses the equity in the house as collateral.

Consolidation Company

When most people think of debt consolidation, they think of the TV and radio commercials that promise them lower payments and debt relief in a few years instead of decades. Working with a debt consolidation company is not taking out a loan. The accounts are not paid off and closed immediately. Instead, the debt consolidation company agrees to work with your debt collectors to reduce fees, interest rates and monthly payments in return for a small monthly fee.

In my experience, this only works if the debt consolidation company is able to garner significant interest rate and fee improvements. Otherwise, it's simply taking all your current credit card payments and the company's monthly fee and consolidating them into one huge monthly payment that's made directly to the debt consolidation company. In return, the company splits the payments, writes the checks and removes their fee. However, individuals who go this route do not have to have perfect credit and no credit check is performed.

Bank Loan

The second way to consolidate bills is by taking out a separate loan. The loan can be unfunded, like a new high limit credit card or based on some type of collateral such as a car or a piece of property. In this instance, the individual takes the loan and uses it to pay off all of their existing debts and closes all the accounts. In return, the individual makes the monthly loan payment. This is great in the loan interest and fees are less than the previous debt interest and fees. It results in lower payments and a faster payoff time. This typically requires a good credit history and score.

Mortgage

The third way to consolidate debt is by taking out a second mortgage that uses the equity in an individual's home. The equity money is used to pay off current debts and close those accounts. In return, the individual only has to keep paying their new mortgage payment. The house is used as collateral. The only downfall to this type of consolidation is the increase in the mortgage payment and the potential to lose the house if the payments are missed. This also requires a good credit history and a decent credit score. Otherwise, the interest charged to the mortgage could increase.

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