Credit Consolidation (Debt Consolidation)

Credit consolidation refers to the same thing as debt consolidation. At the most basic level, the idea is to take out one loan and use the proceeds to pay off several smaller loans. Hence you have effectively consolidated all your debt to the one credit consolidation loan. The main reason to undergo credit consolidation is to have one lower interest loan in place of the smaller (often higher interest) loans. In this fashion, the monthly payment after consolidation will be lower than the combined sum of the smaller loan payments. The second reason is to better manage the timing of the one single payment and therefore have it paid punctually each and every month. In the long run, this one loan being paid properly would result in an improvement in credit for the debtor. In theory this is how it works but in reality it is often difficult to get a low interest consolidation loan. Creditors are acutely aware that people searching for credit consolidation are seeking the solution to usually tame a high total debt, as such they will consider the deal higher risk.

A distinction needs to be made between a credit consolidation loan which you go to a financial institution for and a consolidation service offered through debt counselors and non-profit debt help organizations. The former is a move to restructure your debt and is an option for people who have marketable credit histories. These latter services are similar to a consumer proposal whereby the debtor makes an arrangement through a debt counselor with all creditors. Such a consumer proposal, often incorrectly termed a debt consolidation, is a step used to avoid bankruptcy and will significantly impact the debtors’ credit negatively. Many ‘debt consolidation’ companies which market their services under this term are actually these sorts of organizations that will in essence negotiate an affordable monthly payment schedule with the creditors; hopefully avoiding bankruptcy. If you do not have the necessary income to service the current combined sum of all your debt payments then this is the option to use.

Types of credit consolidation loans

Most credit consolidation loans (opposed to consumer proposals) will require some sort of collateral as security. Since the primary aim of the loan is to reduce the interest burden, it follows to reason that it would not be worth even considering an unsecured consolidation loan since the risk factor would be too high to significantly lower interest rates. The loan is therefore usually accomplished by backing it through unencumbered equity in a house. This sort of secured credit consolidation is by far the most popular option. Personal credit products such as secured lines of credit serve the purpose well. An additional benefit with using a line of credit is that the funds are always available upto the maximum amount of the loan, and there is no need to re-apply if funds are required against the paid down amount of the loan. Unsecured debt consolidation is simply a consolidation loan that is not backed by an asset. It is much more difficult to get approval for, however if you have good credit and have the income necessary to service the consolidated credit, then it may be an option to consider. A major drawback of all credit (debit) consolidation strategies is that you are essentially transferring higher interest short term debts to a long term lower interest loan. While there will most likely be a month to month decrease is cash outlay, the total interest paid in the long term may equal or sometimes exceed the interest that would have been paid in the short term. Due to this, many financial advisors consider debt consolidation to be a way of avoiding the debt and not addressing the sound goal of reducing total debt load. From this angle, only you and your financial advisor are in a position to determine if credit consolidation is the correct and sound course of action.

What should be included in credit consolidation

The prime candidates for a debt consolidation loan would be higher interest credit such as credit cards, department store cards, factoring loans and higher interest auto loans. You cannot include mortgages in a credit consolidation and you should carefully weigh out whether it is worth including other personal loans from grade A lenders. Key advantages of credit consolidation 1) Lower the monthly payments 2) Save interest on higher rate loans 3) Leverage more of the equity in your home (for secured credit consolidation) 4) Manage only one loan payment

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