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What is Loan Consolidation All About?

By Charles Hopkins Published 10/26/2007 | Loans
Problems with bad debt are plaguing people nowadays.  In today's more volatile financial atmosphere, staying on the ragged edge of lending firms' grace and not really attending to a couple of outstanding loans can quickly evolve into a situation which is all but unmanageable to the ordinary person.

Such a situation can still be salvaged, however.  A person faced with such a crisis in personal finances still has options open to him or her.  They are not pleasant and will need sacrifices and lifestyle changes, but the end result of being debt-free should be enough of an incentive.  One need just think of the alternative to it as well.  Chapter 7 bankruptcy, another course of action, will leave a long-lasting negative impression on one's credit record.

The Advantages of Consolidating Loans

One possible course of action is to consolidate one's loans.  What this involves is the taking out of one loan set up to pay off other loans.  A debt consolidation loan offers several advantages.  For one thing, dealing with one loan instead of five or six, with varying interest rates and repayment schedules, is much easier on a consumer.  This loan can also offer a lower interest rate, which is good news for those people saddled with high interest debt balances.  It can also offer the stability of a fixed interest rate for those who need it.

The lower interest rate is made possible because, more often than not, the consolidation loan is secured, i.e., the person offers collateral against the nonpayment of the debt.  This reduces the risk to the lender, allowing them to offer the lower interest rate in exchange for the ability to foreclose on the collateral, which may be in the form of property, possessions, etc.  However, some consolidation deals with combining many unsecured debts into one unsecured debt.

Aside from undertaking loan consolidation for the reasons stated above, people can also consolidate loans when faced with high interest unsecured debt such as credit card debt.  The simple reason why people are in credit card debt is because they spend more than they earn.  Unless they change that habit, no refinancing scheme in the world can help them salvage their finances.  Compounding the problem, the interest rates charged on credit cards are often larger than those offered by traditional lenders such as banks, and so debtors who are willing to put up collateral in order to transform this into a lower-interest secured loan can often pay the loan off sooner, thus, paying less interest charges overall.

Student Loan Consolidation in the U.S.

A special category in loan consolidation has to do with student loans.  In the US, federal student loans are treated a little differently from other types of loans as they are guaranteed by the U.S. government.  This means that when a federal student loan is consolidated, either the U.S. Department of Education or a loan consolidation company purchases and closes the loans (the two types are Federal Loan Consolidation and Direct Loan Consolidation).  A weighted average based off loans of different types and rates is calculated and applied to the new consolidated loan