how does debt consolidation work now?

How does debt consolidation work is often the first question people ask when they are considering debt consolidation programs. And at the root of debt consolidation we need to consider what is the core reason for using such a program. It has to involve at least a moderate amount of debt in the form of credit cards, student loans, car loans (in any combination) to make any sense. The entire point of debt consolidation assistance is to move all of your debt into one loan and lower interest, monthly payments and ease of payback.

As opposed to 10 years ago when credit was easy and everyone was able to wrap up their unsecured debt into one vehicle easily, things are a bit more difficult now.  Home equity loans are a great example of the difference.  A home equity loan or home equity line of credit were often ways people found to consolidate their debt into one central loan.  Borrowing against their homes value was easy because it just kept going up and up it seemed.  Plus to qualify for these loans was easy as the standards were relaxed over time.  Given the occurences of the past few years this is not the case any more.  The standards have been once again reconfigured, this time to be more stringent.  This is a good thing overall, just may make it harder to qualify for a home equity loan.  First off, you need to have some equity in your house!  Translation, your home must be worth more than the loan you are currently paying off as your first mortgage.  The difference between your total loan amount and the current market value of your house is the maximum you can get in a home equity loan. 

Truly a debt consolidation loan is meant to bring about a key change to your debt picture.  Getting a debt consolidation loan is not a negative thing if you use it as a vehicle to get you into a better financial situation.  So what are the key things we want to accomplish in a debt consolidation?

1. Lower your interest rate - if at all possible we want to lower the interest we are paying on all of our loans (or at least on the majority of loans we have).  Paying less interest allows us to pay off the loan quicker and use more money per month to eliminate debt, not make the creditors rich!

2. Centralize all our debt in one spot - make it easy to figure out how much we have left to pay in order to elminate the debt burden.  If your loans are in 8 different accounts it is not easy to figure out your total debt picture.  In one loan it sums it up in one fast look.

So best case you take all of your debt and put it into one loan and use it to beat down your debt and put yourself in a better financial situation.  Hopefully a portion of the debt you have currently was created to help put you in a better financial situation down the road (i.e. you incurred debt for a post secondary education or used your credit card to purchase some high end interview clothes or to bankroll an unpaid internship in your area of work).  If a portion or most of your debt was created in the long term hopes of a better financial future a debt consolidation loan is the best case scenario to put you in a better spot in the future.  Lower interest allows for faster repayment and a quicker path to your upgraded financial future.

Of course there are always pitfalls to debt management schemes.  The key way that debt consolidation will fail is if you end up in the same debt position again only a few years down the road.  The sad part is that means that everything you gain up to the point is lost and then some.  Often you are worse off than you were when you consolidated your debt.  So how would this happen?  If you don't change your spending habits you will inevitably end up being further in debt and the consolidation loan would only be a small life preserver in a monsoon.  Obviously if you built the debt through student loans or a medical emergency you would likely not have those expenses again.  This would be a great example of costs that we would expect to go away.  Finishing your degree would be the stepping stone to your career and thus limiting your outlay in cash for further schooling.  A medical emergency hopefully is something can be straightened out and not an ongoing problem.

However, if you built your debt load through frivalous spending, new vehicles, a fancy wardrobe and the like you will be in for a bad awakening in a short period of time due to the same problems.  For that reason it is important to realize that debt consolidation only works if you are willing to change the behavior that got you in that position in the first place.  Setting a realistic budget and adhering to it are a great way to prove that the consolidation loan was a great move and the first step to a very bright debt future!