Financial Literacy Series: Guide to Using Debt Consolidation Loans

Are you struggling with a mountain of debt, and contemplating debt consolidation to deal with it all? If so, it may be the solution for fixing your situation and getting yourself on the road to financial recovery.

How Consolidation Loans Work

A debt consolidation loan is used to combine your multiple debts of varying terms and interest rates into a single loan with one (hopefully, lower) monthly payment.

You can apply for the loan, either online, in person or over the phone, with the lending institution, such as a bank or credit union, of your choice. All aspects of your situation will be analyzed, and then the loan size and terms will be determined. The lending institution will then pay off all the other outstanding loans you have, and you will become responsible for repaying this new lender with a single payment each month.

In certain cases, consolidating debt can be helpful by replacing multiple high-interest loans with one lower-interest loan. Very often, the reason why people can’t get out from under all their debt is because of the high interest rates on it, and it oftentimes is so high that you can only make the required payments on the interest only, and never on the actual principal.

Consolidating Loans: Secured and Unsecured

Many of these consolidation loans are unsecured – they are funded by the lender without any form of collateral in return.

Other times, they are secured loans and require something major to borrow against — for example, your home. That’s why many consolidation loans are essentially second mortgages. Again, the benefit here is very often centered on the new interest rate you’ll be paying, because the interest rates on unsecured consolidation loans are almost always lower than the interest rates charged by credit cards.

Before you take out a consolidation loan, make sure to sit down with a financial advisor and go over everything in great detail. While consolidating your debt can be helpful, there are also many debt consolidation loan dangers.