As prices for just about everything soars across the country, Canadians are taking on more debt. Recent data found that the average Canadian owes $1.82 for every dollar of disposable income.
Debt consolidation in Canada combines multiple forms of debt into one streamlined payment. In addition, you’ll most likely incur less interest, so you can pay your loans off faster and save money.
By falling deeper and deeper into debt, it’s only a matter of time before consumers need to learn about debt consolidation in Canada. So, what are the ins and outs, pros and cons, and how does it work?
Debt Consolidation Basics
If you have various debts, including loans and credit cards, it’s easy to fall behind when you have different due dates and payment amounts. Not to mention you’re paying interest on all of it. No wonder you’re stressed out and barely scraping by.
In situations like this, debt consolidation will help you simplify your repayment process and lower the interest you pay out of pocket. Here’s how it works.
When you apply for debt consolidation, you’re essentially obtaining a new loan to pay off all your smaller ones. This way, you’ll only have one monthly payment to manage instead of several.
Banks, credit unions, financial companies, and some debt repayment companies all offer different debt consolidation programs.
Pros and Cons of Debt Consolidation
1. Payoff Outstanding Debt Immediately
The greatest advantage of a debt consolidation loan is that all your outstanding debts get repaid. This is especially ideal if you’ve fallen behind on payments and started receiving calls from creditors.
With a debt consolidation loan, those phone calls will stop, and you’ll only have to manage one monthly payment. Plus, you’ll have a set amount to pay every month and know when the loan ends.
2. Payments Become Manageable and Affordable
Holding multiple debts with different minimum payment amounts and interest rates can cause stress in your finances, especially if you get into trouble and incur late fees or missed payments.
Instead, when applying for debt consolidation, your lender will work with you to assess your finances and budget and come up with a reasonable repayment amount each month.
Most times, the new repayment amount will be lower than the combination of all your previous debt’s monthly payment amounts.
3. Lower Interest Rates (Sometimes – see cons below)
Only paying the minimum amount on your current outstanding debt won’t allow you to make much headway toward paying it off. Instead, you’re stuck in the cycle of incurring more interest instead of paying down the principal.
With a debt consolidation loan, you can find an interest rate lower than what you’re paying on your existing debts. In addition, if you’ve kept up with your minimum monthly payments, you might have a better credit score than when you first incurred those debts.
That lower credit score can mean lower interest rates and more money in your pocket every month. You can either sock it away in savings or add extra money to your debt consolidation loan to pay it off faster.
4. You Get Structure
To start, instead of having multiple payment dates and amounts to remember, you’ll have one. Also, with a debt consolidation loan, you’ll know when your loan ends.
This can add structure to your finances and even encourage you to try and pay it off early.
Because it’s a loan, you’ll have fixed terms, unlike lines of credit or credit cards, where terms and conditions vary. This added structure is great for those that need to stick to a strict schedule to maintain their financial wellness.
1. Higher Interest Rate (Sometimes)
I know. I stated above that one of the pros of debt consolidation was a lower interest rate. Now, I’m claiming it’s a con and that there might be higher interest rates. How does that work? Well, it could be either, depending on your credit score.
If you’ve made timely payments on your outstanding debts but just can’t get ahead, that’s when it’s a solid choice to consolidate. However, if you skip payments or had low credit to begin with, you probably won’t be able to get a lower rate than you currently have through your existing loans.
While you can still pay off all your outstanding debt and only have one monthly payment remaining, it would probably come at the cost of a higher interest rate.
2. Might Encourage Spending
Debt consolidation can give you the illusion that you have less debt than you do. If you only have one monthly debt repayment instead of five, it’s easy to assume you have more money than you do. This can lead to overspending and more debt accumulation.
3. Doesn’t Change Your Financial Habits
Combining your debts into one payment might simplify your finances, but it doesn’t solve the root problem – your spending.
If you need to apply for a debt consolidation program, it means you’ve accumulated significant debts.
To improve your financial health and ease the stress of future money woes, you’ll need to take control of your finances and enhance your understanding of budgets and spending.
This is the perfect time to take stock of your money and start a budget. To help guide you, check out one of these apps to make it easier.
Debt Consolidation Options
Now that you know the advantages and disadvantages associated with debt consolidation, how do you go forward?
To start, consider your outstanding debts and the goal you’re looking to achieve. Whether it’s credit card debt or other loans, these are the top debt solution options.
Credit Card Balance Transfers
There are loads of credit card companies that offer balance-transferring credit card options.
Many claim low to zero percent interest, making it a solid financial move. However, these offers usually end after a promotional period w when the interest rates will shoot back up.
The bottom line is that if you do a balance transfer, you’ll want to pay off your debt before the promo period ends. Otherwise, you might get stuck with a higher rate than before.
Debt Consolidation Loan
You can obtain these loans through a bank, credit union or finance company. Most banks and credit unions have stricter requirements but will offer lower interest rates. In turn, finance companies accept more people but have increased interest rates.
Most people looking for a debt consolidation loan have different types of debt – from credit cards to other unsecured loans.
If you qualify, you’re approved loan will pay off your existing outstanding debt while simplifying your financial life with one monthly payment.
Home Equity Loan
One of the more popular ways to pay off debt, a home equity loan, or second mortgage, lets you use the equity in your home (the amount you own after your mortgage) for collateral. Home equity loans offer low-interest rates, making this a smart financial decision.
Line of Credit
You can get a line of credit from your bank if you’re in good credit standing. Additionally, you can snag one if you put up your home as collateral. You can use a line of credit to pay off your outstanding debt, but you’ll need to stay vigilant and disciplined.
You will need to pay off more than the monthly minimum payment if you want to make any progress. In addition, you can’t keep drawing on the line and incurring more debt, or any progress you make will be lost.
Determining Your Interest Rate
Financial institutions typically look at two factors when deciding on your interest rate.
The first is your credit score. If you have a high credit score, lenders find you less risky since you’ve already shown you can repay debt in a timely fashion. Because of this, they’re more likely to award you loans at lower interest rates.
On the flip side, if you have a low credit score, you’ll struggle to find a lender willing to give you a loan without a high-interest rate. That’s because lower credit scores tend to mean those customers are riskier options. There’s a greater chance they won’t pay back the loan on time or at all.
Of course, there are ways to improve your credit score. Ensure all your payments are made on time, pay off your balance every billing cycle, and stay within your credit limits. Looking for other ways to raise your score? Check out these tips.
While your credit score is the main factor in determining your interest rate, collateral doesn’t fall too far behind. Collateral is an asset you pledge in the event you can’t repay the loan.
Most financial institutions are interested in assets that can easily be converted into cash quickly. Real estate is the usual suspect – houses, land, etc., but other items like vehicles will work too.
Generally, the bigger the cash cow your collateral is, the lower the interest rate you’ll get. That means serving up your home as collateral will get you a better rate than your brand-new car.
However, be certain you can make your monthly payments, so you don’t default on your loan and end up losing your home.
Debt Consolidation Program Vs Debt Consolidation Loan
Debt consolidation programs and loans are often used interchangeably, even though they mean different things. Let’s explore their differences.
With a debt consolidation program, an agreement between you, your creditors, and a legitimate credit counselling agency occurs. The agency usually takes care of all the details and typically involves:
- Coming up with one monthly payment made to the credit counselling agency, which they will distribute among the creditors.
- Credit counsellors can also help give you financial tools to help you avoid any future debt. Those tools can include setting financial goals and sticking to a budget.
With a debt consolidation loan, you go to a bank, credit union, or other financial institution and take out another loan to pay off your outstanding debts.
- After paying off all your existing debts, you’ll only have to make one payment with a set interest rate each month.
- As stated earlier, to get access to a loan with a decent interest rate, you’ll need a solid credit score and collateral options.
There are pros and cons to each, and you might find you don’t qualify for the debt consolidation loan because of your credit score. In that case, the debt program might be your best choice.
As with any big financial decision, it’s best to do your own homework to figure out which option suits your lifestyle the best.
Debt consolidation helps you streamline your finances by combining all your debts into a single monthly payment. Of course, figuring out if it’s best for you comes down to many factors, including credit score, outstanding debt amounts, and eligible collateral.
Interested in learning more about getting a handle on your credit card debt? Check out these top balance transfer credit cards.