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Should I Consolidate My Debt?

By Paul Murphy

20-year financial veteran Paul Murphy tackles the tough questions about debt consolidation. From the impact on your credit rating to typical rates for consolidation loans, you’ll learn the pros and cons of using debt consolidation.

Debt consolidation.

It’s a simple concept—you get one big loan to wipe out lots of little debts—but a technique that always causes a lot of confusion.

Today, I’ll answer common questions about whether you should consolidate your debt.  I’ll also share a few words of advice about debt consolidation companies that I have picked up during my 20+ years working in debt restructuring and financial services.

What is debt consolidation?

Debt consolidation involves taking out one big loan in order to pay back lots of small debts.

The advantage of doing this is that larger secured loans—think of mortgages or car loans—tend to have lower interest rates than credit cards or things like payday loans. By getting a lower interest rate with a debt consolidation loan, you’ll reduce the overall amount you’d eventually pay in interest.

This helps you get out of debt sooner as you wipe out old debts and stop interest from accumulating from your unsecured loans.

How does a debt consolidation loan work?

To bring this concept to life, let’s look at an example of how a lower interest rate will help you get out of debt sooner.

Let’s say owe $10,000 on your credit card at an interest rate of 20%. If you pay your credit card $200 per month, it will take you 9.1 years to pay back this debt. And you’ll pay in total $11,680 in interest (in addition to the original amount you borrowed).

If you were able to reduce that interest rate to 10%, you’d only pay $2,989 in interest and pay down your debt in 5.4 years.

This is the basic math that powers debt consolidation: you borrow money at a lower interest rate to wipe out all your small debts. If you owe a large sum of money, this can save you thousands of dollars and get you out of debt much faster.

Most people who use debt consolidation will have several credit cards and small high-interest loans. So borrowing a single lump sum of money with a lower interest rate saves them a lot of money. It also simplifies your debt management as you only have one low monthly payment to remember instead of juggling multiple loans.

If you’d like more basic information on how debt consolidation works, we’ve written a comprehensive 101 guide to debt consolidation here.

We’ve also collected a few of the best credit card interest calculators here. Use these tools to calculate how much interest you’re paying on your loans.

Is debt consolidation different in Canada?

Unlike filing bankruptcy (now known as insolvency in Canada) or using a consumer proposal, there are no specific rules for using debt consolidation in Canada.

But you do need to do your research. Approval criteria will vary vastly from lenders offering debt consolidation. You’ll also see a wide variation in the interest rates and fees.

Clients also often ask us whether debt consolidation is legal in Canada. The answer is of course!

Debt consolidation isn’t a bad thing. In fact, it’s a smart way to avoid getting stuck on a debt treadmill of never-ending interest payments. Corporations use tactics like debt consolidation all the time to avoid bankruptcy.

What’s the difference between debt settlement and debt consolidation?  

Another source of confusion is the difference between debt settlement versus debt consolidation.

As I mentioned, debt consolidation isn’t running away from your debts. You’re simply borrowing money from a lender with the goal of lowering the overall interest you’d pay over several years time.

In contrast, debt settlement is where you reach an agreement with your creditors, negotiating a lower overall sum. In this case, creditors take a hit and so does your credit rating.

If you’d like to learn more about debt settlement strategies, we’ve written a guide that covers the difference between bankruptcy and consumer proposals here.

Is it a bad thing to consolidate your debt?

If you read a lot of personal finance blogs, you’ll hear different opinions about debt consolidation.

Some personal finance experts worry that debt consolidation is only a temporary financial solution. It doesn’t fix the underlying spending habits that led to the debt. Others worry about the high interest rates that some debt consolidation companies might offer.

These are all fair points. But most personal finance blogs are focused on relentless saving and debt-free lifestyles. For many Canadians deep in debt, these goals aren’t obtainable if a family owes $25,000 on their credit cards.

In general, debt consolidation is a positive financial action if it helps you do two things. One, lower the overall amount of interest you’d pay by combining multiple loans into one loan. Two, help you regain financial control by simplifying your debt into one manageable monthly payment.

Does debt consolidation get rid of your debt?

The optimistic view is yes. If you pay your monthly payments and stick to your budget, your debt will disappear. Once you’ve paid back your consolidation loan, you’re back in the black.

The reality, though, is that bad financial habits can be hard to break. Getting a consolidation loan can temporarily lessen the stress you felt.

But as you now have one low monthly payment, it’s easy to start borrowing money again. Soon, a new car appears in the driveway or credit cards that were paid off with the consolidation loan are maxed out again.

At 4 Pillars, we really believe that debt consolidation must include a comprehensive debt management program including education, regular financial check-ins, and proper budgeting.

We see many families quickly fall back into bad habits, even after successfully using debt consolidation to reduce their overall debt levels.

What happens to my credit score after debt consolidation?

The impact of debt consolidation on your credit score depends on your personal situation. As you may know, credit utilization is a key indicator used to calculate your credit rating. Credit utilization simply means the amount of debt you carry compared to the total amount of money you could borrow (your credit limits).

For example, if your credit cards are maxed out and your home’s line of credit is stretched and you also carry several small high-interest loans, very few lenders will be interested in offering you new loans.

With debt consolidation, you’d be borrowing more money so this can impact your credit score as your credit utilization may stretch even further if the other credit facilities are closed when paid out. But it can also have a positive impact in the long run by making it easier to make payments on time.

That said, as your monthly payments are now simplified (with one payment rather than several credit cards and loans) and you’re paying more money against the principle every month, your finances will begin to look up. After a year or so, you’ll be in a much better place and your credit score will begin to rebound.

The other benefit is that while you’ve added a new loan to your credit history with debt consolidation, you’ve also removed older loans (like your maxed out credit card). These paid debts are positive marks on your credit score.

In most cases, debt consolidation will make a positive impact on your credit score over the long run, especially if you make your monthly payments on time.

What are the pros and cons of debt consolidation?

Here’s a quick overview of the pros and cons of using debt consolidation to reduce your debt.

The pros of debt consolidation:

A lower interest rate will potentially save you thousands of dollars and get you out of debt years sooner.

Instead of scrambling to juggle multiple credit cards and loan payments, you’ll have one simple monthly payment.

As you’re borrowing money to pay back debts, any credit cards or defaulted loans will usually be shut down. These will be reported positively on your credit card as you paid them back.

Debt consolidation is generally a positive action for your credit rating. Unlike a consumer proposal or insolvency, there will be no long-term impact to your credit rating.

The cons of debt consolidation:

Your credit rating could take an initial hit as you’re borrowing more money, especially if your debt utilization is already high. But this will be temporary.

Interest rates are higher than a line of credit or home equity loan. But even reducing your existing interest rate by 5% is well worth it and will save you thousands of dollars.

If you owe vast sums of money (such as $50,000 and above), debt consolidation might be the long route to financial recovery. Instead, explore consumer proposals and even insolvency. If you need guidance, speak to one of our local offices.

You might not qualify for debt consolidation. To borrow more money from traditional lenders, you’ll need a solid credit rating and healthy income-to-expenses ratio.

Debt consolidation might not offer a long-term solution to your debt. To stay out of debt, you’ll also need to build a debt management plan.

How do you actually consolidate your debt?

First, you need to review your personal financial situation. Debt consolidation is a fantastic debt reduction technique. But if you owe vast sums of money, have a high expense to income ratio, and have a horrible credit rating, it’s unlikely that a lender will loan you additional funds.

In this case, you’re likely better to choose a consumer proposal. As mentioned, we’ve explained the pros and cons of consumer proposals here.

Next, you need to find a lender. Traditional banks—like RBC or Scotiabank—might offer a competitive rate and are good places to start. But their lending criteria will be strict, demanding solid credit ratings and strong income.

If traditional banks won’t lend to you, you’ll need to find a company that specializes in these types of loans at fair rates.

At 4 Pillars, we do not offer debt consolidation loans, but we can review all other debt reduction options with you so you can make an informed decision which way to move forward. You’re welcome to reach out to us. Remember if you are approved for a debt consolidation loan, but want a second opinion to confirm that debt consolidation is the right option, just contact us for a free review.  

Finally, it’s a good idea to combine debt consolidation with a debt management plan. This involves taking a look at your finances, creating a budget, and making sure that you’re able to make the monthly consolidation loan payments.

A realistic debt management plan will be key to you securing a competitive rate and making sure that this loan helps you build a more secure financial future. I’ve written a post on the 15 steps you need to take to build a successful debt management plan here.

Can you get a debt consolidation loan with bad credit?

As debt consolidation involves taking out a loan, your credit rating and income matter. If you owe less than $10,000 and have a solid credit rating, it will usually be easy to find a lender willing to offer you a consolidation loan at a low-interest rate.

But as long as you can prove to a lender that you’ll be able to make the monthly payments, you can get a debt consolidation loan even with bad credit.

That said, many people start to consider debt consolidation once it is too late. Their debt has ballooned. They might have lost their job. And their credit rating has tumbled.

In these cases, often debt settlement or debt restructuring is a better route to go. It will get you out of debt sooner and save you from slaving away for a decade in debt repayment.

If you’re wondering what debt settlement looks like, you can read nearly a thousand reviews from our own clients who used 4 Pillars’ services to rebuild their financial lives.

What are some common debt consolidation rates?

As I mentioned, the purpose of debt consolidation is to get a lower interest rate than your current loans. But the rate you’re offered by a lender really depends on your personal situation, income level, your net worth or assets you can offer as collateral, credit history, and income-to-expense ratio.

That said, you can expect debt consolidation loans to offer rates between 7% and 15%.

But remember—even shaving a few percentage points from your existing loans could potentially save you thousands of dollars and get you out of debt years sooner.

What’s the difference between debt consolidation and a home equity loan?

In basic terms, you’ll get a lower interest rate with a home equity loan. A home equity loan is known as a “secured loan.” This means that there is an asset attached to the loan, giving the bank or lender more confidence (and legal recourse) when lending to you.

Debt consolidation loans can be both secured and unsecured. Some people may choose to use a home equity loan to consolidate their debt. Others—if their credit rate is low or they’ve lost their job—might not have the home equity option available to them.

What’s the difference between debt consolidation a personal loan?

By now, I think it is clear that debt consolidation is a technique. If you don’t want to work with a company, you’re free to borrow money (whether from a bank or rich uncle) and consolidate your debts by yourself.

Just be careful that the interest rate you get is lower than your current debt—otherwise, you’ll end up paying more money in the long-run.

Another option is to use a credit card balance transfer. For example, if you can find a credit card with a lower interest rate then this can work for people with smaller debt levels.

However, be wary of balance transfer fees, hidden costs, and time limits (such as a low-interest rate that only lasts for a 6-month introductory period).

Should you use debt consolidation?

As we’re getting to the end of this article, I’d like to summarize when a debt consolidation loan makes sense. Debt consolidation isn’t for everyone (for example, if you have excellent credit, you might just be able to get a better interest rate by asking). But it does offer a few advantages.

You should use a debt consolidation for the following benefits:

#1. You’re in debt and scrambling to make payments.

By consolidating everything into one monthly payment, you’ll have less to worry about. And you’ll also start to rebuild your credit as all of your maxed out credit cards and defaulted loans will be paid back by the consolidation loan.

#2. You’ve done the math—and the fees and interest rate works out.

Like any loan or service, debt consolidation companies might charge you a few fees. But it’s really simple to do the math. If your new loan has a lower interest rate and will help you get out of debt faster, then debt consolidation might be a good decision for you.

#3. You’re in debt. But you still have a job and assets.

Debt consolidation can help you get back on track. But if you’re drowning in debt, then you should consider other debt relief options such as consumer proposals or insolvency.

#4. You want to build a plan and schedule to be debt free.   

If you’re tired of juggling multiple payment schedules, then debt consolidation will help guide you out of this mess. You’ll have a simple payment schedule, a manageable monthly payment, and will be able to track the exact date that you’ll be completely debt free.

Where can you get debt consolidation loans in Canada?

As mentioned, a consolidation loan is simply a loan. If you have a high income and low debt, you can go through a traditional lender such as a bank or credit union.

If you have bad credit and a high debt load, you’ll typically need to work with a specialized company or a B lender.

A credit union, for example, won’t likely offer you a consolidation loan if your line of credit is maxed out, your credit cards are stretched, and your auto-loan is in default. So typically you’ll need to work with a debt consolidation company in order to qualify for a loan.

With B lenders and specialized companies, you need to be very careful as their interest rates can be high. In this case, you should carefully review all options available before making any decisions.

4 Pillars’ debt restructuring and debt planning services

If interested, 4 Pillars has offices in every Canadian town and city. We can also help you decide whether debt consolidation is the right path based on your unique situation.

Contact us for a free assessment and consultation.

For a debt consolidation review in BC:

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For a debt consolidation review in Saskatchewan:

For a debt consolidation review in Quebec:

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For a debt consolidation review in Newfoundland & Labrador:

For a debt consolidation review in New Brunswick:

Need more information on debt consolidation?

In our simple 101 guide to debt consolidation, we explain how debt consolidation works, when to use it, and what to watch out for. This guide is written for Canadians and contains expert guidance.

You can also read about the difference between debt consolidation and consumer proposals here.

 

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