The debt consolidation definition can be described as follows: the use of a large loan to pay off smaller loans, or credit card debt. It entails taking out one loan to pay off several others. This is often done when one attempts to get a lower interest rate in lieu of the interest rates they are currently paying.
The debt consolidation definition can entail any number of unsecured loans into other unsecured loan, however more often than not it involves obtaining a secured loan against an asset that serves as collateral, most commonly a house. That is why we strongly recommend that consumers not use this practice. However, hardly a day goes by whereby you do not see an advertisement on television or on the radio, encouraging consumers to do just that. The classic add is to take out a home equity loan or reverse mortgage as if that solves any problems. Perhaps initially, however if only the folks understood the damage they are doing, they would not do it. In this case, a mortgage is secured against the house. The collateralization of the loan allows a lower interest rate than without it, because by collateralizing, the asset owner agrees to allow the forced sale (foreclosure) of the asset to pay back the loan. The risk to the lender is reduced so the interest rate offered is lower.
Sometimes, debt consolidation companies can discount the amount of the loan. When the debtor is in danger of bankruptcy, the debt consolidator will buy the loan at a discount. A prudent debtor can shop around for consolidators who will pass along some of the savings. Consolidation can affect the ability of the debtor to discharge debts in bankruptcy, so the decision to consolidate must be weighed carefully.
Debt consolidation is often advisable in theory when someone is paying credit card debt. Credit cards can carry a much larger interest rate than even an unsecured loan from a bank. Debtors with property such as a home or car may get a lower rate through a secured loan using their property as collateral. Then the total interest and the total cash flow paid towards the debt is lower allowing the debt to be paid off sooner, incurring less interest.