Thursday, April 05, 2007

Consolidating Debt - What Is A Debt Consolidation Loan?

For those people who have gotten into debt over a period of time, they notice that this is can seem like falling in a bottomless pit. First of all making the regular payments on the debt is hard enough. On top if you are simply making the minimum payments then interest charges start to pile up. This snowball effect makes paying back debts harder and harder.

If you are in this situation, chances are that someone has recommended 'debt consolidation' as a viable option. For most people, this seems like the light at the end of the tunnel or a sole path leading back to being back on track. Before you jump into this situation bear in mind that there are advantages and disadvantages to this choice. Knowing both will hlep you make an informed decision.

A question remains, what exactly is meant by "debt consolidation" and how will it save you? In a nutshell, its combining all your debt into a single debt and making one single payment every month rather than multiple ones as you did earlier.

This isn't the case where you simply add up all the different payments into a single payments. It's not like instead of making separate payments of $50, $100, $200 to three different entities you are paying the sum $350 (50+100+200). There are some other things that have to happen to make this work.

1) the total monthly payment goes down or

2) the interest amount owed goes down or

3) the actual total debt goes down

So, which is most likely to occur? That depends on the debt consolidation plan you are taking advantage of.

Very rarely, all of the above take place. The most frequently observed case is that the payments made every month are reduced. The advantage over here is that you are more likely to be able to make payments that you can afford.

Since you can make those monthly payments additional interest and late charges are not applied which would've been had you not been able to make the regular payments. Mentally, you are a lot better off since you have the comfort of knowing that the payments are now under control.

The only real risk in this situation is that if your monthly payments are reduced to the point where you don't think about it too much, you could relax a bit too much. You could fall into the trap of spending some of the money you are saving and end up right where you started. So, don't lose focus on the goal of becoming debt free.

But how do these payments get reduced? One way is by increasing the life of the loan. This is in order of you to pay off the original amount over a longer period of time. In another scenario, lenders are willing to settle for lesser than their original amounts if they believe that they are more likely to lose everything due to nonpayment or a bankruptcy declaration. In this case, lower payments is a less riskier option for them.

Getting out of debt is lot like any other large goal. You have to be consistent an committed to it in the long-term to be successful.

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