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What Is Debt Consolidation

Many people owe debt to multiple creditors, saddling them with complicated monthly repayment schedules and high interest rates. Debt consolidation loans can offer an effective way out of this seemingly never-ending situation. 

Here are some things you need to know about debt consolidation.

Debt Consolidation

What is debt consolidation, you ask? Debt consolidation is basically a loan that you take out to cover your existing debts in exchange for a single, larger debt with easier repayment terms. Since consolidation loans tend to have better interest rates than most other forms of debt, getting one can save you money. That’s especially true if you have multiple credit cards you wish to consolidate. Plastic carries notoriously high rates.  

Not all debt consolidation loans are the same, however. Here’s some info about three common loan types, personal loans, 401(k) loans, and home equity loans.

Personal loans: This is your basic bank loan, usually unsecured. That means you don’t have to attach any of your assets such as a car or your home to your loan as collateral. While rates for unsecured loans are higher than those for secured loans, your assets are not at risk should you default

Still, the best consolidation loans – personal loans – are for those with excellent credit. The better your credit, the better your rates.

401(k) loans: Taking out a loan against your 401(k) to consolidate your debts is doable, although it may not be the best option since you’re tapping your retirement fund. There are also major taxes and penalties associated with early withdrawal from your account. What’s more, if you become unemployed before you pay off the loan, the loan may become due in as short as 90 days. 

Still, some benefits to borrowing against your 401(k) include low interest rates, no loan notation on your credit report, and you’re basically borrowing cash from yourself.

Home equity loans: If you own a home, a home equity loan may be a good option for consolidation. If you’ve paid off a big chunk of your mortgage, you can borrow against that equity and consolidate your debt.

One benefit to this tack is that such loans typically have lower interest rates than other types of loans. Such loans can take up to a decade to pay off, though. And you could lose your house if you can’t repay your loan. Still, taking out a home equity loan could be worth exploring.  

What To Look For In A Debt Consolidation Company

A good debt consolidation company will have fees that are not much more than the national average and will have no hidden fees. A reputable company will also have good customer support and an application process that is easy to manage.

Be wary of unscrupulous companies, however. There are lenders out there who seek to exploit your financial situation. If a company over-promises or is hesitant to answer questions, steer clear. It’s also a good idea to contact your state’s attorney general’s office to see whether there have been any complaints lodged against debt consolidation companies you’re interested in. 

The Takeaway

What is debt consolidation? Well, it could be a good idea, depending on your personal financial situation and the kind of debt consolidation you’re mulling. If you’re determined to get your spending under control, a loan to consolidate your debt could slash your monthly payment and interest rate and set you on a path to financial recovery.

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