Debt Consolidation Basics

• Debt consolidation is the paying off several loans with one larger loan as a debt management mechanism. Many people have loans from several different sources, which each require periodic payments and charge different interest rates. When laden with many loans, borrowers are more likely to miss payments and become confused about their interest rates and how much they owe. When a person consolidates debt, they seek out a lender, such as a bank, that is willing to pay off several of the person's loans in full in exchange for a single, larger loan.
  
  

When to Consolidate

• The main purposes of a debt consolidation are to simplify debt for the borrower and presumably to lower the amount of interest owed. Similar to refinancing a mortgage, the best time to consolidate loans is during a period where the prevailing interest rates are lower than the interest rates on the loans. Another reason to consolidate could be to change variable rate loans into fixed rate loans, to prevent interest rates from rising in the future. While debt consolidation is often seen as an interest reduction tool, consolidations do not always result in less interest owed. Since consolidation involves taking loans at several interest rates and changing them to one with a single rate, the new rate is often an average which lies somewhere in between. Depending on the amount of money owed on each loan, the new rate may appear to be lower while resulting in more interest owed. Another danger of consolidation is that it can lead to the borrower owing money for a longer period of time, since he cannot focus on paying off smaller loans in full. The longer the loans last, the more the borrower will end up paying in interest.
  
  

Student Loan Consolidations

• Debt consolidation can be used to roll up many different kinds of debt into a single loan, but certain types of loans tend to be consolidated more than others. One of the most common types of loan consolidations are for student loans. Since loan consolidators take on a significant amount of risk by backing several of a borrower's debts, they may be unwilling to lend to borrowers without good credit. Since student loans imply a borrower with strong income growth potential, lenders are more willing to consolidate student loans. Another reason student loans are so appealing to lenders is that they are very difficult for a student to get rid of, even in the event of bankruptcy, where most loans would automatically go into default.