How does debt consolidation work?

Having debts is not a problem, but having debts out of your control is a big one. We all know stories like these: someone has taken too much credit than he can afford, someone just cannot cope with bills and other payments, someone has lost a job and have trouble with finding another one. There are also health problems or accidents which bury people down under the pile of their debts. Many things are unexpected, but – let’s be realistic –often it is just our fault that we find ourselves in the red because of our debts.

After the unfortunate year 2007, the financial situation of many Americans looks not very optimistic. We have simply got used to living with debt. However, financial problems bring other trouble. They have a bad influence on family life, relationships and health. Is there anything we can do to reduce our excessive debts before they destroy our life? There is good news – yes, there is. It is debt consolidation which may help families manage their debt and find relief. But how does debt consolidation work exactly?

There are a few ways to do debt consolidation:

A debt consolidation loan

You take a loan which provides money to pay off all your debts. In this way you have only one loan with one monthly payment instead of numerous obligations. Of course, whether it can help depends on the amount of your debt. If you owe a large amount, you will not be able to pay off all your debts with the loan.

Here the solution can be found in a home equity loan, a homeowner equity line or credit (if you have equity in your home). The problem is that you can lose your home if you fail to pay the loan off. And such loans are long term (even 15-30 years). The interest rates are lower, but you will be paying it off for much longer time, which in consequence will cost more.

A balance transfer

If you struggle with a credit card debts you should consider transferring your balances to a new card with lower interest rate (you can find promotions which offer you even 0% for 9-21 months). But, most of cards charge a fee for such transfer.

Credit counseling

This is the next “lifebuoy” for you. You use a service of a credit counseling agency to receive a debt management plan -DMP. Your debt is then managed by a debt counselor who cooperates with your lenders. Instead of a few payments, your debt is consolidated and you make only one payment – to the agency. The disadvantages of this way: lenders close your credit accounts until you complete your DMP, it usually lasts a few years – even 5- to complete the plan, and you must pay a fee (an initial one and then monthly management ones, but these are usually low).

Debt settlement

If you want to reduce your debts, not just move them from one place to another, you can decide to use a debt settlement company. In this way, instead of paying your lenders, you will transfer your money every month to your special account. When there is enough money gathered on this account, the settlement company contacts one of your lenders and negotiates with him so as to reduce your debt.

Unfortunately, this option costs money. Such a company usually takes a certain percentage from the amount of debt it has settled (15-25% of it). Moreover, using such a service damages your credit score, thus, you must think it over very carefully.