Debt Consolidation

Household debt is both a blessing and a curse in modern society. On the one hand, it empowers people with the flexibility to pursue their lifestyle objectives on their own time. However, the financial implications of debt can sometimes make it so that the pursuit of these lifestyle goals is not really worth it in the long run. As consumers become steadily overrun by credit card, mortgage, student, and personal debts, it is becoming more and more evident that we can never have enough financial literacy at our disposal.

By understanding the implications of our debts, we can begin to look at what our options are for alternatives. By understanding our alternatives, we are then able to effective plan for our debts in a way that is most accommodative of our lifestyles, as opposed to simply taking the first solution that a bank presents us with. Over the course of this segment, we’re going to specifically describe how a strategy known as Debt Consolidation can be used to reduce the costs of debt, free up funds for future usage, and improve credit over the longer term.

  • What is Debt Consolidation?
  • Debt Consolidation is the process of taking multiple loans, and combining them into a single larger account. This is done most effectively in situations where a borrower has taken on debt from multiple different credit card providers, and then proceeds to consolidate the loan into a single time planned personal loan in order to pay off the balance.

    However, consolidation can still provide the flexibility of credit card debt by forming under a line of credit instead of a straight loan. Additionally, it can be asset or cash secured, entirely unsecured, or given any number of additional contingencies as an individual loan agreement.

  • What are the Benefits of Debt Consolidation?
  • While Debt Consolidation has the net effect of having no impact on the amount that is actually owed, it increases the amount of interest paid to that one particular lender. This provides that lender with an incentive to provide some additional accommodations to the borrower to encourage them to consolidate. For example, when a borrower consolidates credit card debt under a single time planned loan, the lender may offer a lower interest rate in consideration of the fact that the debt is now on a timeline.

    Lower interest rates, more opportunities to pay down principles, and smaller collateralization requirements are all incentives that a lender may choose to provide under the right circumstances. Additionally, a borrower may find that there is a benefit to having all of their loan payments coming out in a single payment to a single account, because it allows for more effective planning.

    Debt Consolidation also has the potential to greatly improve an individual’s credit rating if they can effectively plan out and follow through on its execution and repayment. By consolidating credit card or line of credit accounts, but keeping the consolidated accounts themselves open, an individual improves their credit rating by freeing up access to available credit.

    This increases the amount of diversity that they have in their credit profile (which represents the amount of experience the borrower has with different kinds of debt), and most importantly, provides an opportunity to make high-frequency payments to close out a debt itself. All of these factors are major contributing aspects of a credit score, and have the capacity to make a dramatic improvement to credit over the long term if properly followed through upon.

  • What is the Downside of Debt Consolidation?
  • While debt consolidation provides many key advantages for individuals that are managing their personal finances, it is important to remember that there are always risks and detriments to pursuing any sort of financial strategy that involves debt. When opening up a consolidation loan, a lender will likely file the application as being an active pursuit of credit, which will decrease a credit score over the short term.

    Additionally, a consolidation loan can sometimes be taken on at terms that are worse for the borrower than they were originally, if the loan was consolidated as part of a package to avoid bankruptcy, or due to default. Lastly, consolidation can involve both securitization and time-planning aspects, which means that a borrower may need to put assets at risk in order to secure the debt, and will not be allowed to simply miss payments until next month without explicit agreement.

  • Who Most Benefits from Debt Consolidation?
  • The person who benefits most from Debt Consolidation is the one who uses it to build credit, and maintains the capacity to continue paying off the obligation throughout the term of the new loan. This is because of the way in which Debt Consolidation allows for an individual to both free up lines of credit, and improve the diversity of the credit file itself at the same time.

    However, in order to do this, the borrower needs to have enough of a credit score to successfully apply for the consolidation loan in the first place. This means that the person who benefits most from Debt Consolidation is an individual that is heavily in debt, but still making most payments on schedule.

  • How Do I Consolidate Debt Effectively?
  • The most effective way to consolidate debt would be over a two year period, so as to maximize the potential benefits to a credit score. The trick is to then make sure that the type of loan used to consolidate maximizes the benefit to the credit file itself. For example, if the file has a poor history for making payments, it would be best to consolidate under a plan that reduces the interest rate in favor of an aggressive re-payment plan that includes high-frequencies, high-value installment payments.

    Alternatively, if the account does not have exposure to a linked-line of credit, it might be best to consolidate the debt into a line of credit that is paid off as soon as possible so as to open up additional funds as access to credit. This might be best negotiated by adding a commitment of collateral to the debt, so that it does not come with too high of an interest rate. By securitizing the consolidation loan against a large asset such as a vehicle, it is possible that this will improve the file’s ability to secure a mortgage because of the way in which it shows experience with similar kinds of debt.

  • What Do I Do After Consolidating Debt?
  • The most important thing to do after consolidating a debt is to make sure that payments are still made regularly on the new amount itself. While consolidation does make things easier to pay off, it doesn’t mean that we get a free ticket. Also, it is probably best to keep credit card and line of credit accounts that have been consolidated open, so that they still count on a credit score as providing access to available credit (a positive factor).

    The trick is then to avoid the temptation of actually accessing these sources of credit through financial planning. As the consolidation loan itself is actually paid off a borrower can begin to move towards the financial objectives that drove them towards consolidation in the first place.

    In many cases, this means that the individual can finally absolve themselves of debt for the short or long term. Alternatively, the borrower may now be better qualified to take on a mortgage to purchase a new home. Whatever that goal was, consolidation provides a borrower with many opportunities to move towards a more stable financial position.