What is debt consolidation?

Debt ConsolidationThe idea behind debt consolidation is simple. You take a number of small, high interest debts, such as credit card balances, and merge them into a single debt consolidation loan. The interest on the loan is lower than on the small debts. Your monthly payment goes down, saving you money. As a result, you can pay off your debts sooner.

Types of debt consolidation

There are two main types of debt consolidation loans: secured and unsecured. With a secured loan, you have to put up an asset, such as your home or your car, to get the loan. Secured loans generally have much lower interest rates than unsecured ones. This is because the lender is taking less of a chance in lending you money. If you cannot make payments within the allotted time, the lender has the right to take whatever asset you used to secure the debt. A secured debt consolidation loan can save you thousands of dollars in interest fees. If you have credit cards with double-digit APRs, you can consolidate them into a single loan at a lower interest rate.

Video: Credit card debt and Interest Go Hand in Hand

However, borrowing money against your home can be risky. If you do not keep up with your payments, you could end up without a place to live. Before considering this option, make sure that you can make the monthly payments. Resist the temptation to borrow more than you need, even at a favorable rate. Find out the exact amount that you will have to pay by the end of the term of the loan. It may be more than you think.

Video: Understanding Debt Consolidation

The other type of loan is an unsecured loan. As the name implies, you do not need to put up an asset as collateral to get the loan. Because of this, the interest on unsecured loans tends to be high. If you are considering debt consolidations, chances are that you have a less-than-perfect credit score. This will also affect the interest rate.

However, even an unsecured debt consolidation loan may have a better interest rate than your credit cards. Make sure that you use a reputable lender and shop around before settling on a credit union or a bank. If you’ve been with the same bank for years, they may offer you a better rate just to keep your business. But if someone else offers you a better deal, don’t feel like you have to stick with the bank you know.

Other options

Debt ConsolidationBefore taking out a debt consolidation loan, you should consider a few other options. Call up your credit card issuer and ask for a better interest rate. If you tell them that you are considering switching to a different card, they may oblige to keep your custom. If you have credit card debts and a good credit score, you may be able to get a new credit card with 0% APR. You can save a fortune simply by transferring your balance.

Did you know that you can borrow money from your nest egg, free of charge? If you have an IRA or a 401(k), this may be a good temporary option. You can use the money in your IRA for up to 60 days interest-free. Only do this if you’re sure that you can return the money to the account within that time.

More Resources


Bank of America

Home Loan Center