How a Credit Consolidation Loan Works

The first decision point is to figure out if your credit consolidated loan will be “secured” or “unsecured.” A secure loan is guaranteed by a specific asset. For instance, a house loan is secured by the house purchased. If you don’t pay the loan, then the bank has a sellable interest in the house and can get their cash back by forcing a sale. An unsecured loan has no such security. If you fail to pay the loan, the lender is out of luck.

The ramification of this difference has a big influence on the cost of the loan. Secured loans have much lower interest charged versus unsecured loans. For instance, a car loan is secured by the car and can be as low as 4%. A credit card is unsecured and as a result can be as much as 19%. The higher interest is intended to offset the potential risk of default by the borrower. In a sense, the borrower is getting as much money as it can up front just in case the overall loan amount is lost later. This usually works in the favor of the lender if done right, even with default.

The second decision is to determine whom you want to borrow from. Various means exist. You can get a credit consolidation loan through a credit card offer, a bank, a financial institution, or by taking a 2nd mortgage (assuming you have real property like a house). Banks tend to give the better rates. The further you go away from a traditional institution the more likely you are to pay a higher rate of interest. However, banks are hard to get loans from in general. Their level of risk tolerance is much lower than that of a credit card company. More than likely, a consolidation loan from a bank will need to be secured against a house or asset. As a result, folks on hard times end up getting help from less than noteworthy sources and get trapped in extraordinary interest charges and fees.

One of the options available is using the assistance of a debt-consolidation company. Do they actually provide a credit consolidation loan? Yes and no. It depends which company you choose to work with. Some will actually create a new loan to wrap all your different debts into. Others offer instead to manage as a go-between with you and your lenders. The second version is not really a loan consolidator as much as it is a liaison. And this second type is more likely to include scams and rip-off artists which we will cover a bit later.