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How Does Credit Consolidation Work?

Credit Consolidation can be a viable debt relief option

Credit Consolidation

Credit consolidation can be a great option when your finances and cash flow are strained to breaking point from paying off debt to multiple creditors. If you’ve got lots of unsecured or credit card debts and the stress of keeping track of various payments and due dates starts to burden you, consolidating your debts may be the most practical alternative.

Keep in mind that credit consolidation is not your proverbial silver bullet that will address all types of debt problems — it may not actually work in some situations and it also comes with its own shares of risks. At the end of the day, however, if you understand what the process actually entails and what your other options are, it does provide an attractive debt relief option. After all, it’s easier to manage one debt and one monthly payment than to deal with numerous debts and multiple payment schedules.

How Credit Consolidation Works

The process of the debt consolidation may seem complicated and difficult, but once you have gone through the process, you will find out that it’s pretty simple and straightforward. Credit consolidation works by combining all your payments or unsecured debts owed to several creditors into one single debt or pool of monthly payment.

After consolidation, you only need to focus on one payment every month. This arrangement is quite attractive to many people dealing with debt payments because it allows them to focus on a single payment obligation and plan to improve their finances and cash flow moving forward.

In instances where the debtor chooses to provide collateral for a debt consolidation loan (to pay off all the other high interest unsecured loans), creditors will agree to lower interest rates which translates to lower payments and savings. Of course, the alternative arrangement would be to get a big enough unsecured loan (balance transfer deals, for example), pay lower interest rates (ideally), and deal only with a single creditor afterwards.

Be Mindful Of The Risks

The risks are there in both options, make no mistake. If something goes wrong and you’ve put up your property (a home, for example) as collateral to your credit consolidation loan, you could end up losing that property.

Even if you managed to consolidate your debts via an unsecured loan, if you’re not careful you could end up saddled with more debt six months, a year down the road. What happens in many cases is that when you pay off all your smaller credit card debts, those cards are available again and for those who are unable to live on a fixed budget and control their spending, that could prove to be too much of a temptation. Sadly, in my many years of counseling people to effectively deal with their debt situations, I’ve seen quite a few who, right after they consolidated their debts, looked like freed prisoners with this huge weight lifted off their shoulders only to return a few months later facing more debt than before.

Financial writer Arnold Anderson agrees that this is a definite risk to some people, “if you do not cancel your credit accounts after they are paid off, then the idea of having several accounts with a zero balance can be an invitation to run up your balances again.”

Ways to Cut Down the Credit

You can have your own credit consolidation method if you understand your financial condition and you really want to do something about it. There are several steps that you can take:

Assess your situation. You need complete and accurate information about your credit cards, your outstanding balances, interest rates, penalties, fees, etc. to get a clearer picture and make an informed decision.

Learn about your options. Check out the various balance transfer options that are currently being offered out there. Try to see if you’re able to secure a significantly lower interest rate than your current average. Sometimes, it’s just not worth consolidating if you end up paying higher interest rates than before. Talk to a professional credit counselor if you’re not sure or if you want an opinion of someone who understands how the credit consolidation process works.

Use your own savings. If this is an option for you, take it. You can start saving up again when you’re no longer burdened with numerous payments and high interest rates.

Close unused accounts and cut the cards. To many people, this last step may be the key to permanently get out of debt. When you choose to consolidate your debts, be sure to close off the other accounts. Keep in mind that you only need one credit card for your needs and one additional card for emergency use, keep it simple and less risky. That’s how credit consolidation works.

 

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