How a Debt Consolidation Loan Works .

A debt consolidation loan is essentially a home equity loan or refinance mortgage, which is used specifically for consolidating high interest debt into a lower fixed rate monthly payment. Fixed rate debt consolidation loans are amortized to be paid off at the end of the term, eliminating the debts.

It's possible to save more money by converting high interest rates, and daily compounded interest on credit cards, and other debt, into a lower rate loan with simple annual interest. More savings may come from tax deductible interest when a loan is placed on an owner occupied residence.

$40,000 of debt at an average credit card interest rate of 15%, might have a payment of about $560 per month, when amortized over a 15 year term. A debt consolidation loan term at 8% would have a payment of about $382 over the same time period, which could save $178 per month. If your goal is pay off your debt as soon as possible, the loan term could be reduced to about 8 years by applying the monthly savings to the debt consolidation loan payments.

In addition to reducing your rates, eliminating compound interest can add to your total monthly savings. In this example, you may save another $50 per month by converting to a simple interest debt consolidation loan, instead of making minimum payments on credit cards. It's possible that daily compounded interest on credit cards can accumulate to more than the minimum monthly payments, which can result in paying interest on the interest accumulating on the account. Consolidating debt into a fixed payment schedule can help eliminate the never-ending minimum payment cycle.