Debt Consolidation : Loan Basics

Debt consolidation is a common reason for taking out a loan - but what is it, and how do you do it properly?

By Michael Strauss

Debt consolidation is one of the most common reasons for taking out a loan, and one which is sure to further increase in popularity as we enter more troubled financial times. Simply put, consolidation is the process of combining all your individual debts into one large one, with the intention of reducing your monthly repayments and/or overall interest charges.

To consolidate your debt, you need to find a loan lender prepared to advance you a loan large enough to repay all your existing debts such as credit cards, overdrafts, and other loans. Ideally, this loan should also have an interest rate less than the average rates of all your existing debts, but this isn't always possible as we'll see later.

Clear Your Debts

Once you receive this loan, you then clear all your current debts and close the accounts, and so you're now left with just a single monthly repayment to make. If you've managed to get a good rate, then this one monthly repayment should be smaller than the combined total of the repayments you were making previously, so giving you more disposable cash each month and lessening the stress of meeting the repayments.

Even if you couldn't arrange a low interest rate, you can still often achieve a lower monthly payment by spreading your repayments over a longer term - albeit at the cost of paying more interest overall in the long term.

Consolidation Drawbacks

At first glance, debt consolidation seems like a perfect way of solving short term financial problems caused by excessive debt repayments. However, there are drawbacks to consider.

Firstly, as mentioned, you'll probably have to pay for the convenience of lower monthly payments with a higher total level of interest paid over the course of your loan term. Many people consider this a price worth paying though.

Secondly, and more seriously, the majority of consolidation loans are secured on the borrower's home, thus converting unsecured debt into secured debt, with the possibility of losing your home if you don't keep up the repayments. This is a serious point and should be considered carefully before taking out a loan - being in debt is stressful, but being homeless and in debt is even worse.

Lastly, there's also the possibility that once you've cleared your previous debts, you can use the card accounts etc to run up new debt in addition to your consolidation loan, leaving you in a worse position than before. This temptation can be simply avoided by cutting up your paid-off cards and canceling the accounts.

Can Consolidtion Solve Your Debt Problems?

So is debt consolidation worthwhile? If you're having serious difficulty meeting your monthly debt commitments, then it can certainly help solve your problems if done thoughtfully and with consideration given to the possible disadvantages and dangers.


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