The Mechanics Of Debt Consolidation

The last decade or so has seen an unprecedented boom in consumer credit, with low interest rates and rising property prices fueling a constantly rising level of personal debt. Most forms of credit have experienced a bonanza, from credit cards to mortgages, with competition among lenders forcing the costs down and the range of features up.

Not surprisingly, this easy access to cheap credit has led many people to rack up debts in the expectation that the good times will last forever. Unfortunately, and predictably, this is far from the case.

Recent turmoil in the money markets has resulted in what many are calling the 'credit crunch', with banks unwilling to extend finance in the same carefree way they previously have, and interest rates are rising almost across the board. This is making the true costs of our debts ever more apparent, and in some senses the chickens are coming home to roost, and the number of people experiencing severe debt problems is rising rapidly.

What are your options if you find that your debts are becoming too much to handle? Somewhat paradoxically, taking out a further line of finance could be an answer, in the process known as debt consolidation.

The basic idea is to take out a loan large enough to clear all your existing debts, paying off all your credit cards and the like, and leaving you with just one single monthly repayment to keep up with. By taking out a loan at a lower interest rate than your current debts, this monthly repayment should hopefully be lower than your total repayments are at present. You can also further reduce the size of your repayments by spreading the loan over a longer repayment term, although it must be pointed out that this strategy will actually increase the cost of the loan over the long term - you'll be paying interest for a longer period, and the total amount you pay will end up being higher.

So is debt consolidation a good strategy to pursue? There's no doubt that when your finances are getting out of control taking a good look at the situation and simplifying it is a good idea, whether or not this involves taking out more credit. Indeed, some might even argue that consolidation is a 'no brainer' - you'll be paying less each month and your money worries will be eased, so what's the problem?

The major potential downside to consolidation is that the loan is often secured on your home, which effectively turns your current unsecured debt into secured debt, with all the risks of foreclosure that that can involve should you get into further difficulties somewhere down the line.

The second problem is that if you've found yourself unable to cope financially, then a consolidation loan may just be a sticking plaster hiding the problem for a few years without actually curing the underlying issues of a non-functioning personal budget. Sure, consolidation can ease the pressure in the short term and if done correctly can be a long term solution to pressing debt troubles, but it should always be conducted in conjunction with a thorough review of your income and expenditure if you're to avoid even more severe difficulties in the future.

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