How Debt Consolidation Works
Contrary to popular belief, debt consolidation doesn't combine all of your debts. At least, not exactly. Debt consolidation occurs when you take out a new loan to pay off your existing debt. You then repay the debt consolidation loan over time. Debt consolidation doesn't reduce the amount of debt you owe, but it does make paying your debts much simpler since you only need to make one payment each month rather than the numerous payments you made before getting the loan.
|Turn numerous debts into one monthly payment|
Consolidating Debts in Collections
Any unsecured debt is available for inclusion in a debt consolidation loan – including collections. If collection agencies are threatening to sue you and the statute of limitations on each account has yet to expire, paying off those collection accounts may protect you from property liens, garnishment and other unpleasant situations in which debt collectors collect the debt by force.
Most collection agencies will set up a payment plan for you if you can't pay off the debt all at once, but being capable of paying off a collection agency debt in its entirety gives you greater negotiation room for a settlement. Although collection agencies will accept partial payments, they'd much rather receive a lump sum. Thus, consolidating collection accounts can be very beneficial for those who have high collections debts they cannot afford to pay.
Debt Consolidation Loan Interest Rates
Unless your collection account started out as a credit card debt and the original contract you signed stipulated that interest charges would continue to accrue should the debt end up in collections, a collection agency cannot legally charge interest on your debt. Unless you can talk the collection agency into forgiving a significant amount of the debt, you'll be paying more over the long run with the debt consolidation loan.
Debt Consolidation Dangers
If you decide that a debt consolidation loan is right for you, make sure to shop around and read the fine print. Not all debt consolidation companies use ethical business practices and, if you fall victim to a scam, you may find yourself in a deeper financial hole than the one you're currently trying to dig yourself out of. Watch out for the following:
- Scam artists: Not all companies that advertise debt consolidation are actually consolidators. Some are debt negotiation companies who take your payments each month and put those payments into a separate account to be used to negotiate settlements with creditors and collection agencies. Not only does this practice destroy your credit scores, it also places you in danger of new collection agencies popping out of the woodwork when your original creditors don't get paid and sell your delinquent debts as a result.
- High Interest Rates: If you have collections on your credit report, your credit score probably isn't stellar. Like any loan, the interest rate on a debt consolidation loan is based on your credit scores. If you do not qualify for a low interest rate, you may end up paying significantly more over time than if you'd ignored the debts and waited for them to simply fall off your credit report.
- Property Loss: Many debt consolidation loans are actually home equity loans and secured by the equity you hold in real estate you own. If future financial troubles result in you defaulting on a home equity loan, you could lose your property to foreclosure as a result.
- Additional Debt: If you include your credit card debt along with collection agency debt in your consolidation loan, it can be very tempting to rack up new charges once your cards are paid off. Even though doing so isn't a bright financial move, I can't even begin to tell you how many people do this. Those individuals are then left paying off their original debt consolidation loan and their new debt.