Debt Consolidation

Debt consolidation works in two ways. The first way is called a secured debt consolidation loan. The debtor rolls his outstanding debts into one and takes out a single loan to pay off these debts. Then he makes a single payment regularly to pay off that one loan. The successful debt consolidation loan has a lower interest rate than the debt that it replaced.

This debt consolidation loan is usually obtained by “securing” it, by putting up a home or valuable property as collateral. By placing collateral on the loan, it limits the potential loss to the lender, allowing for the lower interest rate. By doing these things, debt consolidation usually decreases a person’s monthly payment.

An unsecured debt consolidation loan works like a secured loan, but without the collateral. Being short on security, the interest rate and monthly payment tends to be higher. These loans are typically used by people with no assets and/or poor credit ratings.

Debt consolidation comes with a significant risk. If payments are missed and the loan goes into default, it is possible for the lender to foreclose on the home or claim the securing property. This could happen, for instance, if you suddenly become ill or injured and choose to spend your money to cover those other important expenses. Debt consolidation loans are also an attractive tool for predatory lenders, according to Congressional studies and testimony.