Debt consolidation is one of Canada’s most common debt relief options. But what does debt consolidation actually mean? Simplified, debt consolidation refers to combining multiple debts into a single, larger loan to have fewer creditors to worry about and often lower interest rates or monthly payments.
There are many debt consolidation options that are available. We will examine how debt consolidation works, its benefits for the consumer, the types available, and who should consider it for their debt relief journey.
How Debt Consolidation Works
As previously mentioned, debt consolidation involves taking on a new personal or home equity loan or a new credit card with a high enough credit limit and using this money to pay off some or all of your other, smaller debts. Some balance transfer credit cards even offer special incentives. Some allow you to transfer balances for free, while others offer 0% interest on any transferred balance for a specified period.
Benefits of Debt Consolidation
Debt consolidation comes with many advantages, but also some drawbacks to consider when trying to determine if it is right for you:
- Consolidate multiple debts into one payment: Less payments to keep track of makes it easier to budget and reduces the risk of missing payments.
- Lower monthly interest rate: Depending on your credit standing, you may qualify for a loan with lower monthly interest rates. This can save you hundreds if not thousands of dollars.
- Lower monthly payments: Consolidating your debts into one consolidation loan can lower your monthly payments, especially if some of your other debt is higher-interest credit cards or loans.
Types of Debt Consolidation Loans
As previously mentioned, there are many types of debt consolidation loans available:
Personal Loans
A personal debt consolidation loan is the most common type of debt consolidation. It involves a loan with your bank or credit union, giving you a lump sum amount you can apply to your existing debt, uniting it into one monthly payment. Depending on your credit score, your bank may require collateral, which could be a home equity loan (a second mortgage on your home) or a bank loan secured by an asset (such as your vehicle) or co-signed by a family member or friend.
When you apply for a debt consolidation loan, you must be able to meet the following:
- Your financial institution will likely ask for a copy of your monthly budget to show you can meet the monthly payments;
- You must be working or have enough of a source of income to make your payments;
- You may need collateral (property or a car) or a co-signor; and
- Be able to meet your payments, including interest.
Credit Cards
Balance transfer credit cards can also help you reduce your credit card debt if they have a lower interest rate. We had mentioned above that some of these credit cards offer introductory periods during which you may get as little as 0% interest rate for a specific time on any transferred balances. It’s critical to note that once these introductory periods are over, the interest rate will go into double-digit rates. So, you must do the math beforehand to determine if the interest rate still benefits you.
Another factor to consider is that, in most cases, balance transfer credit cards also charge an initial fee, which can be as high as 3% to 5% of the transferred amount.
Debt Management Plan (DMP)
Another option is an interest-free debt management plan via a non-profit credit counselling agency. One potential advantage of this option is that the credit counsellor may be able to negotiate an interest-free period or a reduced interest rate.
However, a DMP also comes with some distinct drawbacks, such as not being able to include all debts in the plan and having to repay your total debt within 3 years. Compared to other debt relief programs, there is also no debt forgiveness if you are on a debt management plan.
Who Should Consider Debt Consolidation
Debt consolidation may be right for you when:
- Your credit score is high enough to get approved for a lower-interest loan
- You have several smaller to mid-sized debts such as credit cards, payday or car loans
- You could use the breathing room of reduced interest rates
- You could benefit from one payment versus several
There are several significant drawbacks to debt consolidation options. For starters, you must meet eligibility requirements for a consolidation loan. You also must repay your full debt amounts. Unlike with a consumer proposal, none of the debt consolidation options offers debt forgiveness.
Be Debt Free, Talk to Chande Debt Solutions!
Choosing the right debt solution is critical to ensure it is the best solution for your situation. Remember, there’s no one-size-fits-all answer when it comes to managing debt. Each journey is unique, and finding the right path requires careful consideration and, often, professional guidance.
The experienced Licensed Insolvency Trustees of Chande Debt Solutions are focused on personal debt relief and insolvency services. They can help you prepare by examining all debt relief options and devise a strategy to resolve your debts. We know that filing a consumer proposal or bankruptcy is a serious matter, and we want to ensure that you are well-informed and don’t rush into any solutions. All of our consultations are free, without time limits.
Call us today at 416-366-3328 or fill out our convenient online form to learn how we can help you recover financially.
