The Loans Canada team sits down with Gary Schwartz of the Canadian Lenders Association to talk about open banking.
Consolidation: What Is It and How Can It Help My Financial Situation?
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The number one reality of using loan and credit products? You need to be responsible with them, making your regular payments in full and on time always. Unfortunately, this is a notion that a lot of borrowers don’t consider properly before they sign on the dotted line. Those borrowers, drawn in by the prospect of getting the credit products they need, don’t always understand the consequences that will befall them if they should default on their payments. Then, somewhere down the line, they end up with a ton of debt that they’re struggling to manage, and must seek other alternatives for repayment. This is where the idea of consolidating their debts becomes a viable option. They must work out a strategy for grouping their debts together and paying them off as quickly as possible to avoid being stuck in debt for years to come.
Now, before you go swearing off all credit products, as we’ve mentioned in previous articles, not all debt is bad. In fact, a healthy amount of manageable debt is good for the overall health of your credit. The more instances of timely paid bills you have, the higher your credit score will be. The higher your credit score, the better your chances of getting approved for new credit. Then again, having too much unpaid debt on your plate can be detrimental to your credit. When the debt becomes more than you can handle and your credit is being damaged in the process, it might be time to think about consolidation as a way to fix your finances. Below, we’ve listed some of the main debt consolidation options that borrowers turn to in their hour of need and illustrate just how those options can benefit you if you’re currently struggling with debt.
How Does Consolidation Work?
Consolidating refers to merging, combining, or unifying a number of objects or beings into a singular entity. Consolidating has a similar meaning when it comes to paying your debts. Much of the time, it’s not each individual debt that borrowers have trouble taking care of, it’s the sheer amount they have. Having so many different debts (credit cards, lines of credits, personal loans, etc.) spread across multiple lenders and companies can make a regular payment schedule difficult to maintain. When borrowers become so busy tackling all of their debt, high-interest credit card debt, in particular, the overwhelming nature of that struggle can cause them to not only neglect their remaining bills but other aspects of their financial lives.
For ways to consolidate your credit card debt, read this.
So, those borrowers, desperate to alleviate their debt load, will often need to find a way of gathering their debts together (or “consolidate” them), in order to pay them off quicker. Below, we’ve listed 6 of the most common forms of consolidation available to Canadian consumers. However, be warned that each consolidation option does come with its upsides and downsides. For this reason, it’s important to make your decision based on your unique needs.
Debt Consolidation Loans
The first option that many borrowers will turn to is the “debt consolidation loan.” Appealing because of its simplicity, with a debt consolidation loan, the borrower will attempt to pay off multiple debts using a single loan. Debt consolidation loans are most often acquired through primary lenders, such as banks, credit unions, and other traditional financial institutions. Like any type of loan, potential borrowers must go through an approval process, wherein their financial health will be examined. Some typical points of examination will be their credit score, assets, and gross monthly income. Once approved, any debts that qualify (certain loans, like mortgages, usually do not qualify for a consolidation loan), such as credit card debt, car loan payments, etc. can be paid off at once. The borrower then simply has to keep up with one monthly payment to their primary lender until they’re debt-free.
- Consolidation loans usually come with lower interest rates than most other credit products, which can save you money in the future.
- You’ll have a better approximation of when your debt will be paid in full, somewhere between 2-5 years is common, depending on your level of debt.
- Having multiple debts and bills can lead to a jumbled financial lifestyle, eventually leading to late or missed payments. Missed payments will damage your credit score. A single debt consolidation loan is likely going to be easier to manage, which in turn will help you maintain a solid credit score.
- These loans are not always easy to get approved for. Potential borrowers often need to have good credit scores, a solid source of income, and high net worth, as well as assets to offer up as collateral.
- Unsecured consolidation loans (no collateral involved) come with higher interest rates than secured consolidation loans.
- Interest rates are usually higher than home equity loans (see below).
How to Improve Your Chances of Approval
As we mentioned, debt consolidation loans, while being a relatively simple solution to your debt problems, are not easy to acquire. So, if you’ve decided that a consolidation loan is right for you, but your credit score, assets (if any), and income alone are insufficient, you can also try getting a friend or family member to co-sign your loan. If your cosigner does have healthy credit and a high net worth, your chances of getting approval should increase.
Will a debt consolidation loan look bad on my credit report? Find out here.
Home Equity Loans
Also known as refinancing your home or taking out a second mortgage, another route that borrowers can choose is to use their home equity to secure a loan. Similar to a consolidation loan, qualified borrowers will be granted a loan by a lender in order to pay off their other debts. However, in this case, the loan will be taken out against their home equity, the money that they’ve already paid towards their mortgage. Their house will then be used as collateral in the event of a borrower defaulting on their payments.
- Interest rates for home equity loans are typically lower than consolidation loans.
- Most lenders are lenient when it comes to the payment schedule, meaning you can simply increase your mortgage amortization period, then concentrate your efforts toward your other loan payments.
- You must have enough home equity to pay off all your debts.
- Borrowing against your home equity is not free. There are a number of different fees that you’ll have to pay for, such as an appraisal, legal documents, and the application itself.
- Some lenders, banks especially, do not allow you to borrow against your home equity if you do not have enough of it. In fact, they might not approve your loan if you have less than $10,000 in home equity to offer.
Click here for more information about how to borrow using your home equity.
Lines of Credit
A line of credit works in a similar fashion to a credit card, except that you’re borrowing money directly from your bank, rather than the credit card company, and using a debit card instead of a credit card. You can then borrow money up to a certain amount (to be negotiated with your lender), which you can then use to pay your debts. From that point on, you’ll only need to pay off your line of credit in affordable monthly payments.
- Depending on your lender, lines of credit can also offer up some of the lowest interest rates available.
- Because of their minimum monthly payments, you’ll be free to pay off your other debts but can pay the bank back in smaller increments.
- The minimum monthly payments associated with lines of credit can also be costly. If you don’t manage your monthly payments properly, the length of your full payment period, coupled with your variable interest rate, could stretch your debt out for years. You could ultimately end up paying more through your line of credit than you would have with all your other debts combined.
- As we just mentioned, the interest rates that come with lines of credit are usually “variable”, meaning they fluctuate in accordance with the Bank of Canada’s prime rate. So, if the Bank’s prime rate rises, your interest rate, and minimum monthly payments will go with it. Your interest rate could then end up being more expensive than most credit cards.
Click here to learn how to use a line of credit.
Balance Transfer Credit Cards
This leads us to our next option, using a balance transfer credit card to consolidate your debts. When multiple debts, spread over multiple credit cards become too much to handle, another solution that many borrowers choose is to transfer those multiple debts to one “balance transfer” credit card. These cards can be appealing because they often come with very low interest rates, sometimes 0%, for new customers during a limited promotional period. So, with a balance transfer credit card, you can transfer all your debts to a single card, then simply have one hefty credit card bill to deal with, which you can then pay off in increments.
- Similar to a debt consolidation loan, all your debts will be combined into one overall debt. This can make your debt load easier to manage. You can pay it off as you go, with whatever money you have (as long as you at least meet the minimum monthly payments). One month you might only be able to afford the minimum payment, and the next, you might be able to put an extra $1,000 towards your overall bill.
- As we just mentioned, balance transfer credit cards often come with a very low-interest rate for a promotional period, the time of which will vary in accordance with the card’s specifications. If you manage to pay your full debt during that period, you could save yourself a lot of money down the line.
- Once again, only making the minimum monthly payments could land you in even worse debt than you were before. If you don’t manage to pay off your full balance every month, your debt could be stretched out for years to come, costing you hundreds, maybe thousands of dollars in interest.
- Depending on the amount of debt that you need to consolidate, you might not actually qualify for a low-interest, balance transfer credit card.
- Transferring your balance to one of these cards is not free. You will likely be charged a fee for this service, usually 1-5% of the amount of debt you’re transferring. For example: if you transfer $10,000 worth of credit card debt, and the fee is 5%, you’ll have to pay a $500 dollar fee.
- Once the promotional period is over, the card’s interest rate will rise. So, if you haven’t managed to pay your full debt by that cut-off point, you could end up paying just as much in interest as you were with your regular cards, if not more. This can cost you, even more, money in the long run.
- You will likely be charged an entirely different, standard interest rate (sometimes 19.99%) for any new purchases that you charge to your balance transfer card before you’ve paid off your original debt amount. Even if you continue to make payments that are less than the full debt amount, those payments will only be going towards the initial debt. This means that you will continue to rack up interest on those new purchases until you manage to pay off the full sum of your debt, which could be many years.
Want to know more ways to consolidate your credit card debt? Read this.
Debt Management Programs
Similar to a debt consolidation loan, entering a Debt Management Program means that instead of having multiple debts with multiple payment dates, you would just be making one monthly payment until all your debt is paid off. However, rather than making that payment through your bank, you would be working alongside a licensed credit counsellor, who will contact your creditors for you to negotiate a payment plan. Debt management plans are common amongst borrowers who are struggling to pay off their credit card debt.
- Credit counsellors will negotiate with your creditors for a lower interest rate.
- Non-profit organizations also offer free credit and budgeting education programs.
- For cases of credit card debt, borrowers are typically debt-free in 2 – 5 years (the maximum time that most DMPs last is 5 years).
- Once your debts are paid in full, DMP information will be removed from your credit report after 2 – 3 years (depending on the credit bureau).
- Creditors must agree to a debt management program before it can start.
- Credit counsellors that do work for profit often charge hefty service fees.
- Following the completion of your DMP, your credit score will continue to be affected for a further 2 years.
Want to know how long information stays on your credit report? Click here.
Consumer proposals are legally binding proceedings, regulated by the federal government. When filing for a consumer proposal, it usually means that the borrower has a very large amount of debt that they have no chance of paying back entirely. In fact, if you are a borrower and a consumer proposal is your only option, shy of declaring bankruptcy that is, it most likely means that you do not qualify for any of the subsequent forms of consolidation. In this case, you’ll need to hire a licensed insolvency trustee, who will negotiate with your creditors for you to either pay back a portion of what you owe (usually at least 50%) or extend the timeframe within which you have to pay your full debt. Once the proposal is accepted, all actions brought down on you by creditors and collection agencies will cease. You’ll then only have to make a regular monthly payment through the trustee until your debt is partially repaid. Similar to a debt management program, if enough of those creditors agree to the proposal, you should debt-free within 5 years.
- You might be able to consolidate for less than you actually owe.
- There are no interest charges included in consumer proposals.
- If accepted, a consumer proposal allows you to avoid declaring bankruptcy.
- You cannot have more than $250,000 in debt to qualify.
- Consumer proposals are not free. You’ll have to pay an assessment and filing fee (around $1,500). After the proposal is accepted, you’ll also be charged throughout the payment process for the trustee’s services.
- Not all creditors will agree to a consumer proposal. Actually, if the creditors holding at least half your debt do not agree to it, the proposal will not be approved and you may have no other option but to declare bankruptcy.
- If you can’t keep up with your regular payments, your consumer proposal will fall through and you won’t be permitted to file for another (usually after 3 missed payments). Again, this could mean that you’ll end up having to declare bankruptcy.
- Your credit score will be affected negatively during the entirety of the consumer proposal process. Upon its completion, a notice of a consumer proposal will remain on your credit report for a subsequent 3 years. If your proposal lasts 5 years (the maximum permitted time), and the notice stays on your credit report for 3, your credit could suffer for up to 8 years.
Click here to find out how long it takes for a consumer proposal to be accepted or rejected.
Choosing the Right Consolidation Option For Your Financial Situation
Like any important financial decision that you’re making, choosing the right debt consolidation option should take some solid planning. Since each choice certainly comes with advantages and disadvantages, it’s best not to skimp out when you’re doing your research. If you can’t decide which form of consolidation suits you best, try talking to a professional. Seek the help of a financial advisor or credit counsellor for any additional information you may need on your path to becoming debt-free. The sooner your creditors are repaid, the sooner you’ll be able to get your finances back on track for the future.
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