Types of Debt Consolidation

The term debt consolidation can mean many different things to people starting from a general term used when discussing reducing debt, to specific loan types. Traditionally, a debt consolidation loan is a new loan originated by a company used specifically to pay off other loans, such as credit card loans and car loans. The new loan was either originated based solely on ones credit score and history and was considered an unsecured debt consolidation loan, or the loan was originated secured to a property, or other assets. During the housing boom between 2000 and 2007, debt consolidation loans secured to the borrower’s home were the most popular types. Homeowners would get a new first or second mortgage or a home equity line of credit (HELOC) and use the “Cash Out” of the home to pay other bills, mainly credit cards. From a purely interest rate point of view this was a great deal for the consumer because they could pay off the credit cards with high interest rates, usually between 10-20% with a new loan with rates as low as 5%. One of the main downsides of this transaction was that it replaced unsecured debt (where the creditor has limited recourse if the debt is not paid) with secured debt. So if that same consumer had trouble paying one or two credit card companies, their credit score would go down, and depending on their state of residence, they might have to go to court to deal with their debt. But if the consumer did a debt consolidation loan through a new mortgage and the payments were behind, they could lose their home. Trading unsecured debt for secured debt is just one of the reasons why many people have had their homes foreclosed on in the past couple of years.

Thankfully, these types of loans are a thing of the past. It is almost impossible to find a lender that will originate a new unsecured loan to pay off ones credit card or other bills. It is also very difficult to find a home lender that will allow a homeowner to take a significant amount of cash out of their home with a new mortgage. So what types of debt consolidation programs are left?

There are two main types of debt consolidation programs: debt management and debt settlement.

Debt management is a program where all your creditors agree ahead of time to a new interest rate and a new monthly payment. For example, the consumer makes one monthly payment to a debt management company which in turn pays each creditor as agreed. This program is great because it will usually get rid of the credit card debt in four to six years. The downside of a debt management program is that most credit card interest rates are set at 8-10%, (8-10% so if you have rates below that, you might not see as much of a savings. (Another major drawback to this program is that the lack of payment savings. In a debt management program, the consumer usually has to make right around the same monthly payment as their minimum payments to their creditors. This is a major issue for consumers looking for monthly payment savings, which is why they can’t qualify for a debt consolidation or a debt management program.

Debt settlement is another program of choice for many because of the reduced principle balance (most consumers pay back 40-50% of their original balance) and the monthly payment savings. For many, Debt settlement is the best way to avoid having to file for bankruptcy. The downside is that creditors don’t receive monthly payments from the debtor, so the consumer’s credit score can be negatively impacted. While this is a bad thing, the drop in credit score could be worth it if the consumer is saving money and paying off their debt in three to four years.

Conclusion: If you want to resolve your debt relatively quickly, debt settlement might be the right strategy. Depending on your unique scenario, your debts could be resolved in as little as 24-48 months.

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