Debt consolidation comes in three primary forms:  debt consolidation loans, credit card balance transfers, and payment management through a debt consolidator. 

A debt consolidation loan is just another loan. It is used to pay off unsecured, higher cost consumer debt – usually credit card debt – with a lower cost alternative. Basically, you take out a loan at a lower interest rate to pay off your high interest rate credit card balances; then, rather than make many credit card payments each month, you make convenient single payments on the new loan.

Debt consolidation loans are sometimes personal loans but are more often home equity loans. (Yes, some very lucky people still do have home equity they can tap for credit). 

With home equity loans, you use the equity in your home (that’s any value your home has above the balance owed on your mortgage) to secure your loan. By paying off your higher interest rate credit cards with a lower interest rate home equity loan, you may be able to save money and get a tax break as well. Sounds good, right? Right. But before you take that step, stop and consider what you are risking. Do you realize you are swapping unsecured debt for secured debt? Debt secured by your home. If you default on a home equity loan, you can literally lose the roof over your head. 

Personal loans are a lower rate, unsecured loan which, in the case of debt consolidation, would be used to pay off higher cost debt such as credit card balances.  The difference between a personal loan and home equity loan is that personal loans require no collateral and home equity loans are secured by your home. 

Consolidating debt sounds like a simple and efficient way to lower and better manage an out-of-control debt burden, and can be effective if used carefully, but there are many drawbacks. Consolidation loans, whether they are personal or home equity loans, often come with fees and higher-than-expected interest rates, especially if your credit is compromised. And the debt payments can stretch out over many years – sometimes decades – resulting in a higher total cost.

Calculate the total amount you will pay if you continue to make your current payments against the total due on your new loan and see if you’re really better off with a debt consolidation loan. It may cost you more in the long run.  Be prepared to set your credit cards aside – otherwise you’ll find yourself right back in the same soup – with high cost credit card debt and a debt consolidation loan to pay off. 

If you don’t own a house, or don’t have any equity in your home, you may turn to zero-percent credit cards to reduce your debt burden, reasoning that by transferring from, say, a 21 percent interest rate card to a zero percent interest rate card, you will save a bundle. It’s a no brainer, right? Well, yes – for the short term. First, you have to qualify for the zero rate card and that can be tough if you’re already in financial difficulty. The zero percent offer may be an introductory rate that will spike up in six months; and miss one payment and you’re off the island – the rate will reset immediately.

That doesn’t mean a low interest rate card isn’t a good idea. It can be – if you watch the clock like an 8-year-old in Miss Dill’s third grade class and move your balance before your teaser rate expires. But be advised, moving your balance around from card to card, and opening and closing accounts, may adversely impact your credit rating, and that could mean higher interest rate loans when you borrow in the future. 

And finally, you can turn to a debt consolidator for help. A consolidator takes your payment each month and pays your creditors for you, but you still own the debt. Sometimes the consolidator negotiates on your behalf to get your debt reduced or spread out so your payments are lower. Hiring a debt consolidator is something to consider when you are overwhelmed with all the bills you have to pay each month, don't have the confidence to negotiate concessions on your own, and need to simplify your credit situation by writing one check -- to the debt consolidator. There are fees associated with this service. If you're already strapped, it’s more cash out the door. But, if your problem is managing the process rather than not having the cash, this is an option that could help. 

Bottom line: debt consolidation can be an effective vehicle for managing your debt burden. But be informed and do the numbers. Make sure you know what you’re getting into, how it works and what it will cost. You are not helping yourself if in the end you are simply swapping one form of debt you can’t handle for another.