How Debt Consolidation Works

Debt consolidation is one of those terms that gets thrown around so much people don't even know what it means. Debt consolidation is not debt relief, debt negotiation, or bankruptcy.

Actually, debt consolidation is a form of re-structuring financial obligations. Businesses actually do it all of the time. It's a way to take a bunch of small loans and roll them together into one big loan.

The most obvious advantage to all of this is simplicity, but that's not why most people do it. When done properly, debts can often be consolidated into a big loan that's more advantageous to the borrower (lower interest rate, better structure) than a bunch of smaller loans.

An ordinary debt-ridden person can get a loan like this to wrap up several high-interest credit card debts. Let's say somebody owed $10,000 on three cards at rates from 20% to 22% interest. To consolidate the debt, you'd take out a $10,000 loan to pay off the three cards. You're a winner if you can get that $10,000 loan at, say 17%.

But there are other good points to debt consolidation. With one payment instead of three, you're much less likely to get zapped with late charges.

Plus, done properly, debt consolidation actually can improve your credit. That's because you pay off your debts. Those three paid-off credit cards look good on your credit report and may even boost your credit score. (For a great way to understand how debt consolidation can improve your credit, go to www.debt-consolidation-diva.com and check out the "Article Bank" for the last story about credit scores.)

Taking out another loan doesn't necessarily hurt your credit score, and if you pay it off on time, it boosts your score as well.

Debt relief and debt negotiation are plans where you try to make a deal with your creditors to settle your debt for less than you actually owe or to change the terms of your original agreement. This can work, but it will almost always hurt your credit.

Bankruptcy is a scary topic. Guaranteed, it will hurt your credit. It lingers on your credit report for seven long years. And it's an intrusive kind of solution, since you turn over a lot of your financial authority to other people.

For the right people, debt consolidation can be a great solution.