You've seen commercials on television from a variety of credit counseling agencies and debt consolidation and solution companies telling you they can get you out of debt in no time, without bankruptcy.
How can they do that? If you make single payments to them is that the same as debt consolidation? Just what is debt consolidation and does it differ from what you see advertised on television? To illustrate let's use a simple example.
Suppose you have 5 different unsecured creditors and you owe each $4,000.
Your monthly payment to each is $175.
That's a total debt of $20,000 and total monthly payments of $875.
With a true debt consolidation loan, you borrow $20,000 from a single source; pay off the 5 creditors, and then make single monthly payments to the new creditor.
Most of the debt solution plans you see advertised consolidate the five monthly payments into a lower single payment made directly to the company offering the plan.
Your 5 original creditors remain and you will be paying them off either in full or in part over time.
These plans are most often referred to as debt management plans and debt settlement plans.
For both plans you begin by having a credit counselor review your finances to come up with a monthly payment you can afford to make.
Then they'll look at the total you owe, such as the $20,000 in our earlier example.
If the payment you can make is enough to pay off the total $20,000 in 3 years, they put you in a debt management plan.
If the payment won't get you there, they put you in a debt settlement plan which requires them to contact each of your creditors and negotiate a reduction in the total you owe them.
In both cases you are consolidating those 5 separate payments into a lower payment.
Debt consolidation loans are only available through lending institutions and some credit counselors can set you up with one.
However, if your credit is still reasonably good you might get a better deal going to your own bank.
With $20,000 in total debt you will almost certainly need a secured asset, where something of sufficient value is used to collateralize the loan.
Equity in a home is the most commonly used source of collateral.
For smaller amounts it is sometimes possible to get an unsecured, or signature only loan.
These can be difficult to get and come with a high price tag in the interest rates you will be required to pay.
If you think a debt consolidation loan is right for you there are a few things you should know.
First, home equity loans - where you keep your original mortgage - are less costly than refinancing your entire mortgage.
Second, the savings you see every month from eliminating those 5 payments and replacing them with that lower single payment make it easy to forget you really haven't reduced your total debt - only your total payments.
Third, if the credit cards you paid off remain open, it can be hard to resist starting to fill them up with new charges.
For people who end up maxing out their cards again over time, the answer to the question what is debt consolidation all too often becomes it's a pathway to more trouble.