What is Debt Consolidation?

Debt consolidation is the process of gathering various loan obligations into a single "consolidated" account that the borrower pays down month-to-month.

How does it work?

Let's say that you currently hold five credit cards, two overdue leases on business equipment, and other sundry personal loans.  All your separate creditors angling for your attention can overwhelm you with paperwork, interest rate calculations, and notices. 

In theory, debt consolidation clears away this excess "noise" to allow you to restructure debt in a way that minimizes fees and rates and maximizes your flexibility to pay down loans. Simplifying the payback process can save you money and time. To consolidate your sundry debts, however, you often must pay penalties and/or suffer marks on your credit.

Do you need cash to help you consolidate?

Yes, in most cases. Some borrowers with good credit can take out what are known as "unsecured personal loans" to rearrange debts. Others take out money against assets, such as houses or parcels of real estate.

If you have enough stored up equity in a house or other asset, should you get a loan?

Yes, in some situations.  But be aware that when you borrow money against an asset, creditors can potentially seize that asset if you default.  For instance, if you take out a second mortgage and subsequently fail to make terms on that debt, you could lose your house.

Wouldn't you lose your house anyway?

Not necessarily.  Depending on state laws and personal circumstances, debtors can keep their homes under the homestead exemption when they file for bankruptcy under Chapter 7 or Chapter 13.

Are there other cases when it doesn't pay to go the debt consolidation route?

Yes.  Here are some examples:

• The consolidated loan's rate is above the average rate on your current debts.
• Your credit rating can't afford the shock of consolidation. 
• It doesn't make sense from a financial planning point of view to "kick the can" and extend your debt obligations 10, 20, and even 30 years down the line.

Given all the negatives, are there any reasons to choose debt consolidation loans?

Sure.  For some people in certain circumstances, this approach may make a lot of sense. 

Making one monthly payment at a single rate is easier to track for the purposes of your cash flow plan.  Consolidation also allows you to "turn off the spigot" on the stream of harassing letters and phone calls from creditors.

Regardless of how you move forward, identify the chronic spending and budgeting issues that led you into debt in first place.  In other words, consolidation/settlement functions as a financial Band-Aid.  Don't move from personal crisis to personal crisis: take the time to diagnose the root causes of your money troubles.