Does Debt Consolidation Work?

A debt consolidation is a loan program that allows you to consolidate, or put together, multiple loans or debts that you owe into a single loan.  While these programs can be beneficial, they have drawbacks, as well.  Essentially, a bank or other lending institution agrees to loan you a certain amount of money in order to pay off several debts.  You will sign a standard promissory note to pay back the loan at a certain interest rate, and on a specific payment schedule.  Sometimes, the bank will send the loan consolidation proceeds directly to your creditors in order to pay your debts; in other cases, the bank will send you the loan proceeds directly, which you will use to pay off your debts.  In turn, you will begin making payments toward the consolidation loan that you now owe.

Debt Consolidation Loans Lower Your Monthly Debt Payments

In most cases, the whole point of a debt consolidation program is to decrease the amount of your monthly payments towards your debts.  For example, instead of paying $300 per month to Bank A, $500 per month to Bank B, and $200 per month to Bank C, a debt consolidation loan might mean that you only would make one monthly payment in the amount of $700 per month.  In this regard, then, taking out a debt consolidation loan has saved you $300 per month. 

Debt Consolidation Loans May Cause You to Pay More Interest

Inn order to give you a lower payment and accommodate the combined amount of your debts into a single debt consolidation loan, the bank must stretch out your payment schedule for such a loan over a longer period of time.  This means that you may end up paying more interest over the life of the loan than you would have paid by paying off your original debts.  Plus, depending on your situation and your credit history, you may be paying a higher interest rate on the debt consolidation loan than the interest rate that you were paying on your original debts.  If you are carrying several high-interest credit card debts, though, a debt consolidation loan with a fixed interest rate may result in a lower interest rate than that for your original debts.

Using Home Equity Loans as Debt Consolidation Loans

Many people seeking debt consolidation loans first look to a mortgage lender for a home equity loan in order to consolidate their debts.  These types of loans allow you to tap the equity in your home to pay off other bills.  Plus, all, or at least a portion, of the interest paid on a home equity loan is deductible for federal income tax purposes, as opposed to interest paid on other types of debt consolidation loans, which is typically not deductible for tax purposes at all.  While this can be an effective strategy for some consumers, it can be a pitfall for others.  If there is a chance that you will be unable to make the payments on your home equity loan, your home is the security for that loan, and you can lose your home if the payments are not made.  With an unsecured debt consolidation loan, or even with multiple debts that you might have prior to consolidation, you are not at risk for losing your home if you fail to make your payments.

Consult an Attorney Before Entering into a Debt Consolidation Loan

As you can see, debt consolidation loans can be very advantageous for some people, and not so appropriate for other people and their financial situations.  Therefore, be sure to contact an attorney in order to explore all of your legal options in terms of your debt burden before committing to a debt consolidation loan.