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What Is Debt Consolidation?

If you're up to your neck in debt, you may be considering debt consolidation. Obviously, there are some pros and cons when entering a debt consolidation program and to qualify you generally need to have at least $7,500 in unsecured debt.

To qualify for debt consolidation you will have to meet the company's minimum requirements. This is usually a credit rating in the mid 600 range, although some bad-credit lending companies may accept a credit score as low as 580. Be aware that bad-credit lenders will often charge higher fees because you are a higher risk. Also, most companies will require collateral in the form of home equity with larger loans

Here's how debt consolidation works.

The way that debt consolidation works is like this. Let's say for example that you have four different debts, all of which total up to $1,100 a month in repayments and you can't afford to keep up with the payments anymore. Instead of defaulting on your debt or filing for bankruptcy, you could consult a debt consolidation company.

The debt consolidation company will contact all your lenders and negotiate a deal to pay off all your loans for you. Usually, they will be able to get a deal for you between 25% to 75% off the total debt.

They will then pay off the loan for you, and you will owe the debt consolidation company the money instead of your previous lenders. 

So, instead of having to make four payments every month, you will only need to make one. Your monthly payment to the company is usually significantly lower than your previous monthly loan payment amount.

Remember That They Also Need to Make Money

Keep in mind that debt consolidation companies, even if they're a non-profit company, need to make money or cover the expenses as well.

Be aware that some companies will structure their program in such a way that you're actually paying more at the end of the day, but the lower monthly payments will be in the affordable range.

For example, they may be able to lower your $1,100 payment down to $700 a month while extending your loan terms by 24 months. Your monthly payment may be less, but because of the extended loan terms, you may be paying more overall.

It is really a trade-off. The company needs to make money to operate. After all, it is a business and they are taking on your debt for you. But if you aren't able to afford the higher monthly payment to your original creditors, then a lower monthly payment with a higher overall payment my be better for you.

How Does Debt Consolidation Affect Your Credit?

Settling debt is not as good for your credit rating as paying the debt off in full. However, it's definitely better than not paying it off at all.

How it will affect your credit rating will depend in part on how much you defaulted on your repayments before debt consolidation. It also depends on whether or not your creditor charged off your debt to a debt collection agency.

If your debt has already been charged-off, the charge-off will appear on your credit report even if the consolidation company manages to reach a settlement with the collection agency. 

Working with a debt consolidation company shouldn't lower your credit score. However, settling for paying an amount lower than the total you originally owed, defaulting on your debt, and getting charged off will all add up to negatively affect your credit rating.

However, unless you were able to settle the whole debt in full, these would negatively affect your credit whether or not you consolidate your debt.

Debt consolidation is not for everyone, but if you want to save yourself from filing for bankruptcy it may be your only option.

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