What Is Debt Consolidation

When a consumer takes out a new loan to pay off two or more existing loans they are said to be "consolidating" their debts. The objective of taking this action is to reduce interest rate charges, lower monthly costs and simplify your debt problem by only having one payment to make each month.

If you have gotten to the stage where you feel debt has taken over your life with no end in sight then debt consolidation may be an option worth considering. Remember however that without taking the time to learn a little about the process you will be at the mercy of the consolidation company who will often try to sell you an inappropriate product. The more you learn for yourself the less chance there is that you dig yourself into an even deeper hole.

There are a variety of products you can use to consolidate your debt, the most popular are:

1. A regular unsecured loan from a lender such as your local bank -

The majority of standard, unsecured loans used for debt consolidation purposes in the UK are taken out with one of the large high street banks. These loans have the advantage that you don't have to put your house on the line, this however means that they are riskier from the lenders point of view making them more expensive.

2. A secured loan which uses you home as collateral for the loan -

Lower risk for the lender means much better rates for you when you cosolidate your debts with a loan secured on your property. Of course, the major downside is that you could lose your home if you can't keep up with repayments. It is these loans which are regularly advertised on daytime television by companies eager to capitalise on your misfortune.

3. Transfering your debts onto a single credit card -

Negotiating with one of your credit card providers you may be able to get a reduced interest rate if you willing to transfer all your outstanding credit card debt onto the one card. Another option is to move your debt to a credit card which offers a 0% introductory rate which will give you an interest rate holiday, allowing you to concentrate on paying off the money owed.

There isn't a huge amount of information available on the demographics of the people who use consolidation loans because of a lack of data collected by lenders when releasing loans.

What we do know is that there is no hard and fast rules about the types of people who resort to these loans in an attempt to control their finances. People who are considered both high and low-risk by lenders are known to use these products as part of their financial plans although we believe that the reasons for doing so varies greatly between individuals.

One of the larger user groups of the consolidation loan are the younger members of society who are in full-time employment. This makes sense as this group is the biggest user of credit products in general and is more likely to be caught up in the instant gratification of the consumerist society.

Swapping several high interest loans for one lower-interest consolidation loan has a few obvious benefits which can have a beneficial effect on your financial situation.

1. Manage to find a consolidation loan with a lower interest rate and in theory you will be repaying a smaller total amount.

2. With a consolidation loan you will only have one loan to pay off each month, simplifying your debt problem.

3. Prevent further damage to your credit rating. 

As advertised on television you would think the consolidation loan was the answer to all the financial problems you could ever think of. Unfortunately, and perhaps inevitably, this is not the case. Before taking the advice of any debt consolidation company it is important to be aware of a few of their disadvantages.

1. A Debt Consolidation Loan which is secured against the value of your house risks you losing your home if you don't keep up with repayments. 

2. Pay close attention to the total amount you are required to repay. Its possible that although a loan looks like a better deal because of smaller monthly payments, longer repayment terms could mean that the loan costs you more in the long run.

3. Inflexible loan terms may mean you are punished if you want to repay ahead of time. 

4. Resist the temptation to take further loans on top of what you already owe even if offered by a consolidation loan company. This will only add to your problems. 

Many people decide to take a consolidation loan with the very first company they talk to after beig tempted by the lower monthly payments they are offered. Would you buy the first car you saw in the first garage you passed while walking down the street? I hope not!

Done correctly the consolidation loan has the potential to improve your life but there's a few things you have to keep in mind if you are to act in a financially responsibe way.

1. Only work with banks, building societies and reputable debt consolidation companies.

2. Ensure that the loan you are being offered is going to work out as a better deal for you. Just because a loan has a lower monthly payment compared to what your current debts cost doesn't necessarily mean you will be saving money over the term of term of the loan.

3. Seriously consider the other options that are available to you such as negotiating with creditors, getting help from a free counciling service or entering into an Individual Voluntary Agreement.

4. Be aware that most lenders and brokers do not give independent advice. Try The Citizens Advice Bureau for impartial advice if you feel overwhelmed by debt.