If you are like most Americans, you have a mountain of debt, and perhaps have extended your finances to the point that you have been late on payments or even defaulted on some of your existing loans. A few financial missteps can often have dire consequences when it comes to your credit report and score, but debt consolidation can allow you to slowly rebuild your borrowing history to a more favorable position while you get yourself out of debt, once and for all.
How Debt Consolidation Works
In debt consolidation, a servicer will pay off all of your existing debts and you, in turn, will make just one payment each month to your new lender, usually at a much reduced rate of interest. The lender will place a lien against your home until you have completely repaid them for the amount of money extended on your behalf to pay off your previous lenders.
It is important that you know the risks of debt consolidation when placing your home up as collateral to secure funding; if you default, your lender can foreclose upon your home to receive payment. For this reason, many folks elect to go for unsecured debt consolidation, which does not involve pledging collateral. However, for the bad credit borrower, it is hard to be approved without giving the bank something to hold on to as security.
When you decide to go forth with debt consolidation, always do some comparison shopping to determine which lender offers the best deal. Never agree to a payment that is beyond the reach of your budget. Pay special attention to the interest rate that you will be charged during the process - even a half-point difference can save (or cost) you thousands of dollars in future payments.
Ideally, your debt consolidation should have a term of five years or less, although there are some borrowers who extend it for up to ten years. The idea behind it is to become debt-free, and that is most easily accomplished when you have a term that is short and allows you to see the fruits of your efforts in the least period of time.
Changing Your Spending Habits After Debt Consolidation
Your previous behavior as a borrower has resulted with you having a less than stellar credit score. Debt consolidation will allow you to pay off your existing debts, including those that are costing you outrageous amounts of interest. However, any credit card balances that you had will now be brought back down to zero, which often causes the borrower to start accruing more debt.
Your best bet: close all of your credit card account except for the oldest and most established one that you have. Use this one credit card to purchases necessities that you must have, and pay it off each month other than running one-third of the available credit line as a balance. This will add points to your credit score. Avoid impulse buys or splurges, and become a good steward of your available credit in order to improve your financial outlook.