The concept of a ‘debt consolidation loan’ is whereby one will take out a loan in order to service the interest for or pay off other loans. The merit that could be perceived in doing this is in order to obtain a lower interest rate than might be otherwise being paid. Additionally, it might be to consolidate multiple loans into one item. They can be on the one hand from various unsecured loans into one individual unsecured loan. However, perhaps more popularly they may be to secure these debts against an asset in the sense of using it as collateral – a common item in this regard might be a house. In this example a financial device known as a ‘mortgage’ is used to secure debt against the equity of a house.
The benefits of that to the borrower would be that the rate of interest would be lower perhaps – this could be because of the perceived lower risk of default to the lender. In the instance of lending against a house for example, the borrower would agree to the ‘foreclosure’ / forced sale of the asset in question to pay back the money owed to the lender should the situation arise where they would not be able to continue to service the debt.
In the instance where the borrower is in danger of bankruptcy, the lender might ‘discount’ the amount owed in an attempt to avoid that scenario. Moreover, there might be the potential for the debtor to seek around for those who could give the highest savings in this regard. However, by undertaking consolidation this might affect the debtor’s potential to claim bankruptcy, so that particular tack should be undertaken with careful consideration.
A particular situation where this might be considered of most interest would be in the situation of credit card debt when the rates of interest might already be considered exorbitant – in that situation even when the loan is unsecured it might apparently be less than that is required for the credit card repayment amounts. As a result of having to pay less money on interest, the debtor could then focus more money into repaying the debt that was owed in the first place.
In terms of this situation there has been a lot of negative press about this type of payment in recent years. For instance, although the repayment monthly amounts may be reduced in actual fact, the total amount that may need to be repaid could be higher than would otherwise be the case. Thus this type of alternative whilst apparently appealing on face value might actually not be the best option for all people when they have considered all the potential options that are at their disposal.
Other options that might be able to be considered as opposed to the option of debt consolidation loans could include credit counseling, debt settlement and personal bankruptcy. Moreover, some debt consolidation loan lenders may negotiate with the creditors on behalf of the debtor in the same way as a credit counselor might.