A consolidation loan is a loan obtained in order to pay off several smaller debts. For example, an individual might have a dozen credit cards with an aggregate balance due of $12,500; fourteen pending automobile installment payments of $650 each; a past-due telephone bill of $700; and a past-due gym membership balance of $250. Instead of making payments on all these debts one at a time, the individual might go to a credit union and obtain a loan for $22,550 to pay off all the smaller outstanding debts; the loan will perhaps be secured against the automobile. Usually, the credit union will disburse the funds directly to each creditor to ensure the money is actually used to pay off debts. The single credit union loan-the consolidation loan-will usually have a lower interest rate than some or all of the other loans. In addition, the other loans are paid off and any collection activity will cease. The individual now has a single monthly debt payment.
There is a catch, though-numerous studies have repeatedly concluded that most people obtaining a consolidation loan will rapidly accumulate numerous new smaller debts. The psychological feeling of being suddenly "out of debt" apparently contributes to this behavior. It’s critical, therefore, that if you get a consolidation loan you realize you are not "out of debt" and that the consolidation loan must be paid off before new debts are accumulated.