What Is Debt Consolidation?

Are You Sure It Means What You Think It Means?

What is debt consolidation? Well, as if figuring out how to get out of debt wasn't confusing enough, the term "debt consolidation" has to go and take on two completely different meanings on top of it all.

So if you find a company offering debt consolidation, beware that they may provide a service that has nothing to do with what you are looking for. Well, at least the "helping you get out of debt" part will be the same, but other than that...

What Is Debt Consolidation? Definition #1

I don't have any statistics to back this up, but my guess is that when most people hear the term "debt consolidation" they think "loan". In other words, they envision getting a new loan to pay off their existing debts. This strategy can work under certain circumstances, but it is important to remember that you cannot get out of debt by borrowing more money. A debt consolidation loan can be a valuable tool when used within an overall debt reduction plan, but on its own it will not get you out of debt.

The basic premise of this type of debt consolidation is to get a new lower interest loan and use it to pay off all of you high interest unsecured debt. If you have equity in your home, securing a new loan using your home as security, can be a viable strategy. But if you are looking for a consolidation loan that is unsecured, you may have a more difficult time. If you already have significant unsecured debt, finding someone to loan you money, or at least loan you the amount of money you require at a favorable rate, will be a difficult task.

Not all is lost if this is your situation however, because the second type of "debt consolidation" may be better suited to you anyway.

What Is Debt Consolidation? Definition #2

The second type of debt consolidation does not involve any loans, nor does it involve the consolidating of any debts. What is consolidated however, are you debt payments. Let me explain.

When you join a debt consolidation program, it will be administered by a credit counseling agency or debt management company. The program works like this. First, a certified debt counselor will fully assess you financial situation, and work on preparing a budget for you to follow. At the same time you will receive money management tips and other personal finance education.

Next, your counselor will contact all of your unsecured creditors and attempt to negotiate lower interest rates (sometimes as low as 0%) and try and get them to waive any penalties or late fees on your accounts. They will also speak with your creditors to try and work out more favorable payment schedules if necessary. By doing all this, it should allow you to pay down your debts much faster. This is due to the fact that the interest you are being charged each month is reduced significantly allowing more of your payments to be applied to the principal portion of your debts.

Then, each month you will make one "consolidated" debt payment to the credit counseling agency or debt management company, who will in turn make all the necessary payments to your creditors. The goal of a debt consolidation program is to have your debts paid off in 5 years or less.

As you can see, considering how different these two types of debt consolidation are, it's no wonder why so many people ask "What is debt consolidation?"

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