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Debt Consolidation

What is a Debt Consolidation Loan?

Debt consolidation means uniting all the individual debts into a single debt. A loan taken to cover all individual loans under a single entity is called a debt consolidation loan.

Debt consolidation usually involves a secured loan against an asset—a house, for example, that will serve as collateral. Because of collateralization, the asset owner or the borrower agrees to allow forced sale of the asset to pay back the loan. This reduces the risk to the lender and results in a lower rate of interest.

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What are the Benefits of Debt Consolidation?

A debt consolidation loan permits the borrower to use the equity built up in his home to pay off his creditors. The borrower can use a debt consolidation loan to consolidate all his bills into one low interest account, thereby easing his financial burden.

In addition, a debt consolidation mortgage greatly reduces the risk of late payments, as only one payment has to be made per month.

A debt consolidation loan can also help eliminates credit card debt. A borrower can pay off all his credit at once, thereby reducing monthly payments. This leads to substantial savings on interest over the long term. However, you'll also be increasing your repayment amount, since interest accumulates over the loan term. Please consult with a financial advisor on whether extending credit over a longer term is right for you.

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Types of Debt Consolidation

Debt consolidation loans can be found in three types:

Low-rate credit card: This is when a borrower transfers the accumulated credit card balances to one single card with a rate that is less than he is currently paying. However, borrowers must be judicious enough to read the entire terms and conditions, and be aware of attractive teasers with damaging long-term consequences if the conditions are not met precisely.

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Home equity loan: This is the best way to reduce interest costs on homes. Interest rates on a second mortgage are always lower than on other mortgages since a second mortgage allows the lender to sell the house in the event that the loan is not paid back. In addition, a home equity loan may be tax deductible, making the effective rate of interest lower. Consult a tax advisor to determine if you may qualify for tax deductions. Before securing a home equity loan, a borrower must make sure he can repay the loan, failing which his house could be seized.

Counseling agency: A borrower may appoint a counseling agency, usually a third party, to arrange lower rates and longer paybacks with his creditors, and then manage the repayments by himself. However, it is often pointed out that borrowers should ideally try to repay debts on their own.

Although a debt consolidation loan or mortgage is apparently free of any disadvantages, it has often led to potentially destructive spending habits. This is usually the result of the peace of mind which borrowers attain after consolidating all their individual loans into one low-rate loan. If such habits can be curtailed, and provisions to repay the debt are identified, there is no harm in applying for debt consolidation loans and mortgages.

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