Debt Consolidation, What is it?

We recently went to a conference where attendees were between the ages of 20 and 35.  We asked them, “What words do you often hear associated with debt that you are the most confused about?” The answer: What is debt consolidation, what is refinancing, and what is the difference between the two?  This age demographic has heard these terms and should be familiar with them.  The reason being is that they are associated with student loans and to a lesser degree credit cards.  In this article, I explain debt consolidation.  For an explanation of refinancing click here.  Also, if you have questions about debt consolidation, most likely your peers do as well.  Please like this article and send it to your friends.

Debt Consolidation (Student Loans)

Wikipedia’s explanation is one of the simplest: “Debt consolidation is a form of debt refinancing that entails taking out one loan to pay off many others.”  When it comes to student loans, the most common debt consolidation is done through a direct consolidation loan.  A direct consolidation loan is a government program that allows you to combine multiple federal education loans into a single loan.  Many private companies are also emerging that will consolidate both federal and private loans into a single loan.

The resulting interest rate is a weighted average of your prior loan rates. For example, you have two ten year loans of $10,000 each. One has a rate of 6% and the other a rate of 8%.  Let’s say you decide debt consolidation is right for you and consolidate them into one ten year loan.  After debt consolidation, your new loan would have a ten year term, a principal balance of $20,000, and a 7% interest rate.

Why Do People Tell Me to Consolidate and Lower My Payments?

If your monthly payment decreases, it’s the result of a lengthening of the term.  Since the interest rate is not reduced, federal loan debt consolidation is generally not a money-saving option.  It is best to illustrate using an example.  To follow along or to do these calculations for your loans you will need a financial calculator.  An easy to use calculator can be found at Calculator.net.  If you would like a more “sophisticated” debt consolidation calculate you can visit bankrate.com.

To explore how to calculate a consolidated loan and apply it to your situation click here.

So what should you do?  That is a question that can only be answered on an individual basis.  In my article entitled Consolidate Student Loans, Is It for Me? I explore this topic further.  As always, your friends most likely have the same questions you do.  Please share this article with them.

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5 Comments on “Debt Consolidation, What is it?

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  3. It is very correctly mentioned in the article that by consolidating your debt, you haven’t reduced it all but you have reduced your overall interest rate slightly, but if your finances are out of control, the interest rate is almost never the problem, and whatever tiny reduction you got by consolidating won’t make a dent in the rate at which you end up paying it off.

    1. When you consolidate your Federal loans you do not reduce the interest rate and yes if your finances are out of control then consolidation doesn’t do anything to help you.

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