Just as it sounds, a debt consolidation rolls multiple lines of consumer debt, usually credit cards, in to one line with a lower overall interest rate and a single monthly payment. Debt consolidators will target the higher interest credit cards first, paying more to them to knock down the outstanding balances at a faster rate. If that process works as planned, instead of just paying interest charges each month, the consumer will eventually be able to put more money each month toward reducing the outstanding principle as long as payments remain constant.
The collateral used in this type of debt relief is most often consumer’s equity in their home. When credit requirements were quite a bit more lax than they are today, unsecured debt consolidation was commonly available and made financial sense if the interest rate of the new loan could be materially reduced.
In the current environment, the vast majority of debt consolidations are secured by the consumer’s property which makes this strategy quite a bit riskier than with an unsecured line. That risk in the transaction comes from the fact that the consolidation is now replacing unsecured debt in the form of credit cards and consumer debt into secured debt collateralized by the consumer’s home. With the home now at stake, if that consumer starts falling behind on payments within the debt consolidation program the lender can start a foreclosure forcing the borrower and his family out of their home.
It’s an outcome the consumer would not have to contemplate even if he defaults on all his credit cards and consumer loans. Making debt consolidation even less appealing is the fact that despite taking on so much risk the borrower doesn’t see any reduction principal owed, may see only a slight drop in the monthly payments, and could be making payments on the consolidated debt for years to come. When the exchange into another form of unsecured debt was a possibility, debt consolidation was a reasonable financial decision. Trading into a situation where the consumer risks the roof over his family’s head is clearly not the right call especially when better options, like debt settlement are readily available.