Debt consolidation is the process of taking one loan to pay of all or many other loans. The primary advantage is that since the borrower is taking one large loan he gets a lower interest rate because of economies of scale. He also has the bonus benefit of dealing with one lender instead of many.
Often lower rates are given for consolidated loans because consolidated loans are generally secured loans, whereas the other loans may be unsecured. In a secured loan the borrower provides collateral against the loan. This may be an asset like a car or a house. If the borrower is unable to pay the consolidated loan, the lender has the option of taking possession of the asset, disposing it and recovering his dues. This is known as foreclosure of the asset. Since the lender’s risk is reduced because of the collateral, he can offer lower interest rates.
A large number of debt consolidation activities arise from credit card debts. In the consumerist society we live in, people overspend using credit cards and are unable to pay the monthly credit card dues. This results in credit card debt, which carries an extremely high rate of interest. The best way out in such cases is to go for debt consolidation. However this must be combined with prudent spending in the future so that the consolidated loan is paid off in time.
Sometimes it is the original lenders who go to debt consolidation companies. When a borrower defaults, the original lender can come to difficulty. He needs the funds immediately but does not have the resources to enforce the payment. In such cases the lender sells the loan to a debt consolidation company at a discount. The debt consolidation company reschedules the payments and at times even passes on a part of the discount to the borrower, especially if the borrower can offer collateral. By this arrangement all parties benefit.