What is Debt Consolidation and How Does it Work?

Debt consolidation is one form of debt management that will allow you to group all of your debt together. For example, maybe you have three high interest credit cards, a personal loan, and a tax lien that you are paying on. With all of this debt, it is possible that you are having trouble paying even your minimum monthly payments. In addition, if you are able to just squeeze in your minimum payments, you probably realize that you aren't reducing your original balance by much - and that's because most of your money is going toward interest.

For someone who is looking to get out of debt, this can be a depressing scenario.

But debt consolidation could possibly be just the answer you're looking for. In this type of credit management, you would take all of those loans - the credit cards, the personal loan, and the tax lien - and you would consolidate them into one loan. There are several ways to go about the consolidation process. You could:

Negotiate a lower interest rate from one of your credit card lenders and transfer all of the balances onto that card
Take out a lien against your mortgage
Work with a credit counseling company
Take out a debt consolidation loan from your bank or credit union.

At this point, you may be wondering if debt consolidation really works - after all, it sounds too good to be true. The answer is yes, but only if managed correctly.

Find the Lowest Possible Interest

Whenever thinking about debt consolidation as a method to manage and reduce your debts, you should have two main goals in mind. The first is to get a low interest rate on whatever consolidation loan that you get. For instance, if you are paying 18 percent on your credit cards, and 10 percent on your personal loan, then it would do you no good to consolidate with a loan that pays 20 percent. Instead, look for a loan that will allow you to reduce your interest payments so that you can pay off the balance quicker.

Create a Workable Plan

Secondly, you should strive to achieve a monthly payment that you can afford. Can you imagine struggling to make combined monthly payments that total $300 per month, but after consolidating them, only having to pay $150 each month? What's more, with a lower interest rate, more of your money would go toward paying the actual balance, which would allow you to pay it off quicker.

Another key to make debt consolidation work is to have a plan and then stick to it. For example, once you know the specifics of your loan, you should have a definite date in mind when all of your debt will paid off. Be specific, but also be realistic. It might take you two or more years, but you can be assured that at the end of the time period—provided that you make all of your payments on time and don't charge anything else - you will be debt free. Now, isn't that a wonderful thought?

Summary

Debt consolidation is the process of merging all of of your debts into one
Debt consolidation works well for those with numerous debts with higher interest rates
You can consolidate your debts yourself, or you can work with a credit counseling company
Find a loan with the least interest to consolidate your debts into
After consolidating, create a realistic repayment plan that you can stick to

Now that you know what debt consolidation is, learn more about the agencies that can help you implement consolidation and help you with other credit-related issues in All About Credit Counseling