Debt consolidation means taking out a new loan to pay off a number of liabilities and consumer debts, generally unsecured ones.
In effect, multiple debts are combined into a single, larger piece of debt, usually with more favorable pay-off terms: a lower interest rate, lower monthly payment or both.
Consumers can use debt consolidation as a tool to deal with student loan debt, credit card debt and other types of debt.
There are several ways consumers can lump debts into a single payment.
One is to consolidate all their credit card payments onto one new credit card – which can be a good idea if the card charges little or no interest for a period of time – or utilize an existing credit card's balance transfer feature (especially if it's offering a special promotion on the transaction).
Home equity loans or home equity lines of credit are another form of consolidation sought by some people, as the interest on this type of loan is deductible for borrowers taxpayers who itemize their deductions.
There are also several consolidation options available from the federal government for those with student loans.
Creditors are willing to do this for several reasons – one of them being that it maximizes the likelihood of collecting from a debtor.
These loans are usually offered by financial institutions, such as banks and credit unions; there are also specialized debt-consolidation service companies.
There are two broad types of debt consolidation loans: secured and unsecured.
Secured loans are backed by an asset of the borrower’s, such as a house or a car, that works as collateral for the loan.
More traditional, unsecured debt consolidation loans, which are not backed by assets, can be more difficult to obtain.