Two Types of Debt Consolidation
Debt consolidation is taking out a big loan to cover one or more smaller loans. In essence, you borrow an amount of money large enough to pay of the loans you have. Rather than having many small loans, and many payments, and multiple interest charges, you end up with only one loan, one monthly payment, and one interest charge. This can, in the long run, save you a great deal of money in interest. It also makes it easier to make payments, as you do not have remember to send a separate payment for all of your obligations.
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There are two very common types of debt consolidation. Both of them are loans.
One of them is an unsecured loan, taken out to cover a relatively low debt burden.
The other common debt consolidation loan is a home equity loan. This type of loan often allows you take out more money, as it is secured by your home, to consolidate a greater amount of debt.
An unsecured debt consolidation loan is usually made in order to cover amounts of debt totaling less than $10,000. Much of the time, you will be hard pressed to even cover that much debt with an unsecured loan. At any rate, it is unsecured because you offer no collateral to cover. If you own a car, it is possible to turn that unsecured loan into at least a partially secured loan. But if you default, you lose your car so that the lender can recover some of the money lent to you. You can expect to pay a higher interest rate on an unsecured debt consolidation loan. Rarely is there any allowance made for you to have extra money as well. Most lenders of this type of loan actually pay off your existing balances directly. You never actually get the money in your hands. Your debts are paid off, and now you make one payment the new debt holder.
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A home equity debt consolidation loan is based upon the value of the equity in your home. If you have a great deal of equity, you can get a larger amount of money to pay off debts, sometimes tens of thousands of dollars. What happens is that you refinance your home for more than what you have left on your mortgage. If you have a home that is worth $100,000, and you've paid half of it off, you can refinance the remaining $50,000 and add any number up to $100,000. If you need $30,000, you refinance for $80,000. The $50,000 pays off your old mortgage and you keep the remainder. This is because the home is an asset that can be sold to recoup any losses resulting from a default. Many people use the equity in their homes to consolidate debt, and then make sure there is a little left over for a trip or home improvements. One should be very careful not to borrow more than needed, as this can cause problems. Some unscrupulous lenders and scammers will actually encourage you to take out a bigger loan than you can afford. When you default they can come in and take your house. You should always be conservative in borrowing to prevent loss of your home.
Debt consolidation can help you out of a tight spot, but you should use it as part of a plan to ultimately rid yourself of debt, rather then increase your debt.
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