What Is Debt Consolidation?
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What Is Debt Consolidation?
Millions of people seem to be asking the same question over and over again: what is debt consolidation?
We can begin answering the question “what is debt consolidation” by understanding what debt consolidation is used for. In essence, customers who are in debt may take out a new loan (it has many names, but is often called a “debt consolidation loan”). This new loan is used immediately to pay off existing debt.
The new loan is pegged at a lower interest rate those that it replaced. So for example, if you had 3 credit cards with a combined $5,000 in debt, and each card demanded 20% interest per year, your new $5,000 loan at 10% a year saves you 10% in interest right off the bat!
But wait: this information, alone, is not enough to help you answer your question “what is debt consolidation?”. In fact, far too many people fail to take their learning one step further. As such, they only have half an answer to their “what is debt consolidation” question and often pay the price for it down the road. This won’t happen to you, however, because we’re going to complete the answer right here.
Returning to the example above, you now have an extra $500 a year to “spend”. But - and this is an important but! - this doesn’t mean that you should only give $500 to the loan and keep the other $500! If you do that, then you won’t actually reduce your debt; it was $5,000 with the credit cards, and it’ll be $5,000 with the new loan. Are you starting to see how we need a more complete answer to the question “what is debt consolidation”?
I think so! So as you can now see, you want to take some of that “extra” $500 in saved interest, and apply it to the principal of the consolidation loan. Even if you only allocate $250 a year to the new loan, that’s still going to lower the principal and the interest payments as well.
So memorize the information in this article and if you’re ever asked “what is debt consolidation?” on a test - or in real life - you’re sure to pass with flying colors!
