It is no secret that many Americans today are overwhelmed by some form of debt, whether its student loans, credit cards or mortgages. In fact, the American philosophy may well be, “in debt we trust.” Many are faced with the challenge and stress of paying monthly debt obligations often on the verge of succumbing to personal financial ruin or eventual bankruptcy. One of the ways in which individuals try to address the issue is by consolidating their monthly debt obligations.
What Exactly Is Debt Consolidation?
Debt consolidation Definition: Debt consolidation is a ‘convenient’ financial tool (often a loan) that combines multiple, individual debt obligations into a single payment plan.
In essence, the process known as “debt consolidation” is an effort to simplify or streamline all your monthly debt payments into one affordable monthly payment. The rationale, of course, is that it is much easier to pay one versus several monthly payments. Although in theory this may seem like a great idea, keep in mind that this ‘simplistic’ logic may not be so simple. In fact, there may be additional costs associated with specific consolidation options. You need to look past the allure of an initially lower payment amount and learn about the types of plans that may be most appropriate for you in both the short-term and long-term.
Option one: Debt consolidation payment plan
A debt consolidation payment plan is a plan designed and administered by a third party such as a credit counseling agency, whom you would authorize to negotiate with creditors to help reduce and pay off your debt. The plan allows you to make a singular monthly electronic payment to the credit counseling agency who in turn takes those funds and makes the various monthly payments to your creditors. Some agencies charge a nominal fee for the service while others do not. This type of debt consolidation payment plan is not debt consolidation loan. Note: you may also hear this referred to as a “debt management” or “debt repayment plan.”
Option two: Debt consolidation loan
A debt consolidation loan, as the name suggests, is a loan designed to consolidate your existing debts by paying them in full with the proceeds of the debt consolidation loan. You are basically transferring the debt into a new loan with one monthly payment. Because debt consolidation loans offer short-term affordability, it often means payments will be lower but loan terms will be longer and perhaps more costly. You should also take careful note of the interest rates being offered as they could be higher than the rates currently offered on your existing debt.
Things to keep in mind before using a debt consolidation loan
Borrowing your way out of debt is counter intuitive. As a matter of common sense we generally don’t use fire to put out a fire. Why then would we try to borrow our way out of debt?
Address the underlying problem
Being in debt does not occur overnight. It is often preceded by a number of factors which may include job loss or prolonged illness, but more often than not, poor financial habits. It is critical that you address the underlying problems which led to the path of overwhelming indebtedness. Developing discipline and the savings strategy necessary to avoid a financial crisis should be a major priority. Whether it is done individually or with a professional, building a financial action plan to help address the core issues will be key.
You may end up paying more $ over time
There is big difference between a consolidation payment plan and a debt consolidation loan. By consolidating all or part of your debt obligations into one payment, makes it much easier to afford and manage. However, you must clearly understand the overall financial consequences of borrowing to pay off debt. Loans consist of principal and interest. The longer the loan the more interest you pay. Again, you may feel a sense of relief in the beginning by lowering your monthly payments, but when it all said and done if you’re already in debt, borrowing is the last thing you should be thinking about.
For anyone struggling with debt, the good news is that there are options available to you, just make sure your consolidation option doesn’t lead to more indebtedness.
4 Steps to Getting out of Debt
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