Somebody asked me the question: how does debt consolidation work? This is a good question and  I suspect that there are many people who don’t know the answer. If they did, they would use it to their advantage.

Debt consolidation comes into play when a person has multiple loans or obligations, and does not have the means to pay off the debt. Their may be debts from mortgages, home loans, car loans, credit cards etc. By consolidating your debt, you take out a loan (e.g. home equity loan) with a low interest rate and consolidate all existing loans into one new one. As a result your new liability is covered at a much more favourable interest rate.

Practically, what it means is: you take out a loan at a low interest rate in the amount that equals the sum of your various debts. You use the loan to pay off the debts that you have in the various places. You may not realize this, but it can be a significant money saver.

Another advantage of Debt Consolidation is that your financial situation becomes much more transparent. All you have to do is check the one account and you will know what your position is. This helps you focus on the problem and as a result most will have an easier time staying compliant.

Debt consolidation means you are taking 2 or 3 credit cards, and "consolidating" them into one loan. Preferably you would take out a personal loan at an interest rate much lower then the rate your current cards are. You use the loan money to pay off your credit cards and than you make monthly payments to pay off your loan. Because of the lower interest rate, you should be able to get rid of your debt faster and with less expenses.

Just be aware of a major trap that many people make. STOP USING CREDIT until you get this loan paid off. I’ve seen many people go this route, only to once again charge up their now-empty credit card. Then they are twice the amount in debt, and end up filing for bankruptcy. Stop spending more than you have coming in (if at all possible).