What Is a Consolidation Loan?


The Internet is a great place to search for information about just about anything – even answers for people who are drowning in debt. But sometimes you read things that leave you confused rather than illuminated. As an example, you thought you knew the answer to the question, “What is a consolidation loan?” until you read about debt consolidation programs. What is it and does it differ from a debt consolidation program?How Consolidation Loans WorkWith a loan you borrow money from a single source to pay off several existing debts. If you currently owe $15,000 to 3 different credit card companies you consolidate those three debts of $5,000 each into a single debt of $15,000 which you borrow from another source – a bank or some other financial lending institution.You’re left with the same amount of debt but a lower monthly total debt repayment. The best place to start looking for a loan is with your own bank or mortgage holder. Mostloans use equity in the home as collateral. If your equity is sufficient, you have a verifiable and stable source of income, and your credit is still in reasonably decent shape, you have a chance at getting a loan.Consolidation Loans versus Debt Consolidation ProgramsWith what are commonly called debt consolidation programs, the total debt remains with the original creditors either in part or in full, but the monthly payments are combined into a single payment paid monthly to the provider of the program. Some programs involve paying back all you owe within 3 – 5 years, while others require a negotiated reduction in the principal you owe each creditor to allow repayment in the allotted time frame.Advantages of Consolidation LoansFirst, you will almost always get a consolidation at a much lower interest rate than you are currently paying on the unsecured debt you are consolidating.Second, the lower monthly debt repayment will leave you with more income at the end of each month.Third, as long as you can continue making timely payments on the loan, your credit rating remains unchanged.Disadvantages of Consolidation LoansThere are two ways to use your home to get a loan – a total refinance or a home equity loan. Generally speaking, a total refinance is for an extended period of time and although the interest rate is lower, the extended repayment period may end up costing you more than had you maintained the original accounts.The most serious disadvantage is a flip side of one of the major advantages – lower monthly payments. This can give the uniformed the impression they actually have more money when they don’t. If you owed $15,000 before consolidation you still owe $15,000 afterwards.The extra money at the end of the month coupled with the fact that credit cards that may have been maxed out prior to taking out the consolidation loan now have zero balances can be a combustible combination. Some people fall into the trap of recycling old behaviors and soon the credit card balances begin to rise and you can end up in a more troubling situation.