Debt consolidation is the act of using a new loan to pay off a bunch of existing loans or lines of credit (like credit cards).  Debt consolidation can be a good way to better manage your debt to help you get out of debt quicker, but it is important to make sure that you fully understand the terms and conditions of the deal.  There are many debt consolidation lenders out there that don’t always have your best interest in mind, so do your homework prior to using any firm.

How It Works 

If you are going to consolidate your debts into one loan, you usually get a loan that has a lower interest rate that your current loans.

For example, if you have:

Credit Card: $10,000 at 20% APR

Credit Card: $5,000 at 15% APR

You could get a consolidation loan for $15,000 at 10% APR.  Not only does this consolidate your payments into one account, it also has a lower interest rate that your previous lines of credit, so you will save some money in the process.

 Things To Be Aware Of

In order to get these types of loans, there are several things you should be aware of.  Lenders don’t like lending money to people in debt, so the fact that you can do this should be a red flag.

The first thing to be aware of is collateral requirements.  Many lenders require some type of collateral, whether it is a car or your home.  As such, if you do stop paying your new consolidation loan, the lender can go after these assets to recover the money lent.

Second, you should be aware of any fees involved in getting the consolidation loan.  Many lenders can charge 1% to 20% in fees.  If you were to get a loan that charge just a 10% fee using the above example, you suddenly added $1,500 to your debt.  That new debt may exceed the total amount of savings you would have received by consolidating your loans.  Be very careful when it comes to lender fees.