The process of taking smaller loans, or credit card debt, and putting these obligations together into a larger loan is called debt consolidation. The borrower can often lower their total cost of credit by leveraging the lower interest rates and administrative costs associated with the larger consolidation loan.
The debt consolidation process usually involves taking unsecured loans, such as credit card debt, and turning them into a secured loan, such as a second mortgage on a home. This means creditors have a legal claim to the property, if the individual should default on the loan through a pattern of nonpayment. Consolidation loans provide the individual with tax advantages that are not available with other kinds of debt payments.
Debt consolidation is an alternative to other debt reduction, or elimination, choices such as budgeting, bankruptcy, debt negotiation, or seeking the help of a debt counselor.
In addition to the potential for a tax deduction, the benefits of a consolidation loan typically include:
- Lower rates of interest since the loan will be secured by collateral
- One monthly payment versus tracking and monitoring a number of smaller payments to creditors
- A clearer understanding of the total money owed to creditors (total debt load)