Understanding Debt Consolidation

With so many references to debt consolidation services in today’s media, you would assume that the term would be one that is well understood. Unfortunately, many indebted consumers have either an inaccurate or incomplete idea of exactly what debt consolidation is and, more importantly, how to make good financial decisions on matters related to it. The truth is that it can be a somewhat ambiguous term until it is discussed in some more detail. Consolidation itself merely means to combine two or more things into one. In order to gain a clearer understanding of what consolidation means within the context of debt, let’s discuss the two most common forms of debt consolidation.

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Debt consolidation is having more than one debt

First, debt consolidation can refer to a situation in which a consumer has more than one debt, for example several credit card accounts, a couple of loans or a mix of the two. If the interest rates on these debts are high, the consumer may opt to take out a lower-interest loan (by refinancing his home, taking out a line of equity, etc.) and use the proceeds of the new loan to pay off the individual debts. The consumer has consolidated his debts into a single larger loan, and now makes a single monthly payment toward the new consolidated amount. This new monthly payment will usually be lower than the combined payment amounts of the original debts, will take advantage of some other aspect of the situation (e.g. income tax deductible), or both.

Debt consolidation is seeking professional debt relief assistance

Second, debt consolidation can refer to a situation in which a consumer seeking debt relief obtains professional assistance from a debt solution company. These companies will, among other duties, assume the task of effectively bringing together the consumer’s debts and combining them in such a way that the consumer will make only a single monthly payment. The payment will be made to the debt solution company, who will in turn pay the individual creditors. In this instance, the consumer is making a consolidated payment toward the individual debts; however, the debts themselves are in fact still separate and have not been consolidated.

It is also important to understand that there are different types of debt solution companies that use a variation of the second form of debt consolidation just discussed. A debt management company (a.k.a. consumer credit counseling) will offer the consumer a consolidated payment. The payment will be based on the full amount of the debts involved and any interest charges, as well as the cost of the program itself. A debt settlement company will also offer the consumer a consolidated payment, but the monthly payment will be based on the combined negotiated amount of the unsecured debts involved, as well as the cost of the program. Lastly, even a Chapter 13 bankruptcy filed by an attorney will involve a consolidated payment to the trustee toward the debts included. Of course the attorney will charge a separate fee for his services.