Legal Definitions - debt consolidation

Debt consolidation is the process of combining multiple existing debts into a single, new debt. The primary goal is often to simplify repayment by having only one monthly payment, potentially secure a lower overall interest rate, or extend the repayment period to reduce the size of individual payments, making the debt more manageable.

Here are a few examples to illustrate debt consolidation:

• Credit Card Consolidation: Imagine a person named Alex who has three different credit cards, each with a balance, varying high interest rates (e.g., 18%, 22%, 25%), and different payment due dates. Alex finds it challenging to keep track of all the payments and is paying a lot in interest. Alex decides to take out a personal loan from a bank at a fixed, lower interest rate (e.g., 12%). Alex uses the funds from this personal loan to pay off all three credit card balances in full. Now, instead of making three separate, high-interest credit card payments, Alex only has one monthly payment to the bank for the personal loan, often at a more favorable interest rate and with a clear repayment schedule. This demonstrates debt consolidation because multiple credit card debts were combined into a single personal loan.

• Home Equity Loan for Debt Payoff: Consider Maria, a homeowner who has accumulated several smaller debts, including a car loan, medical bills, and a few store credit accounts. Each of these debts has a different interest rate and payment schedule. Maria has significant equity in her home. She applies for a home equity loan, which is a loan secured by her house, typically offering a lower interest rate than unsecured debts. Maria uses the proceeds from the home equity loan to pay off her car loan, medical bills, and store credit accounts. Now, her only debt (apart from her primary mortgage) is the single home equity loan, simplifying her finances and potentially reducing her overall interest expenses. This is an example of debt consolidation where various unsecured and secured debts are rolled into a single, new secured loan.

• Student Loan Consolidation: Sarah has completed her university studies and has several federal student loans from different academic years, each with a slightly different interest rate and a separate monthly payment due date. To simplify her repayment process and potentially secure a single, fixed interest rate, Sarah applies for a federal Direct Consolidation Loan. This new loan combines all her eligible federal student loans into one new loan. As a result, Sarah now makes only one monthly payment to a single loan servicer, rather than managing multiple payments for individual loans. This clearly illustrates debt consolidation in the context of student financing.