Debt Consolidation Explained

Debt consolidation is a non-bankruptcy debt resolution method which involves negotiations with all unsecured creditors (ie. credit cards, medical bills, collection agencies, etc…) in order to combining all unsecured debts into a single “consolidated” debt amount. Unfortunately, creditor participation is entirely voluntary and not all creditors are willing to reduce interest rates or abstain from charging fees. When creditors do agree to participate in a debt consolidation, often, the consolidated interest rate is be less than the interest rates on all debts (if totaled separately). Because of possible reductions in interest rates and/or fees often means a consolidation payment amount is lower than the previous separate minimum payments amounts due. While it may be a lower monthly payment amount, lower doesn’t necessarily mean faster, and in the long run, a debt consolidation plan may call for payments over a longer period of time (typically anywhere from 36 to 60 months). Depending on the deal negotiated with one’s creditors, debt consolidation may help maintain one’s credit score. In order to get creditors to reduce interest rates and fees, most accepted debt consolidation plans contain strict provisions/penalties for missed payments, and do not allow any new credit accounts/debts be opened for the duration the consolidation plan. Typically, if one fails to comply with a debt consolidation plan, all consolidated creditors can re-instate their debts to the original terms, which can have a serious negative impact on one’s credit report.

Common Misconceptions about Debt Consolidation 

There are two common misconceptions about Debt Consolidation worth nothing here. The first misconception about debt consolidation is that one’s total (or principal) debt is reduced in a debt consolidation. Unfortunately, debt consolidations rarely involve debt reduction/forgiveness, and the full amount owed to all unsecured creditors is the amount eventually repaid to all creditors, plus interest (albeit at a lower interest rate, and less fees, than before). Another common misconception about debt consolidation is that debt consolidation includes all types of debts, including secured debts (ie. car loans, home loans, etc…). Unfortunately, Debt consolidation does not help reduce or repay secured debts, despite the recent rise in foreclosures. This means if one considering debt consolidation falls behind on mortgage payments, and is in danger of foreclosure, debt consolidation will not help delay or stop the foreclosure nor will it help repay back owed mortgage payments so the person can become current.