Debt Consolidation Traps to Avoid

Debt Consolidation Traps to Avoid

Written by Caitlin Wood
Last Updated November 4, 2021

We all know what it’s like to fall into the debt trap. You start out great figuring that you’re never going to run into problems with money. You never spend more than you have in the bank and credit cards are no big deal. And then it all falls apart. We have definitely all been there and the process of getting out of debt is, of course, a whole lot more difficult than getting into it.

The problem with getting out of debt is that there are many different debt relief options available, each with its own pros and cons. Debt consolidation loans are particularly tricky as they can bring about as much chaos as they can peace. When using a debt consolidation loan, there are a number of factors you need to consider before using it. 

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Debt Consolidation 

Debt consolidation is a debt relief solution many Canadians use to consolidate all their high-interest unsecured debts. The goal is to reduce the amount of interest paid on the debts,  so more money goes towards bringing down the principal. It’s also a way to make a person’s monthly payments more affordable by taking on a longer-term. 

Overall, a debt consolidation loan can make your debts more affordable and manageable as you’ll only have to worry about making a single payment. However, depending on your credit score, income, and debt level, a debt consolidation loan can leave you in more debt than before. Here are the biggest debt consolidation traps to watch out for when you’re looking for help with your debt.

Qualifying  

While debt consolidation is a preferred option over other debt-relief options like a consumer proposal or bankruptcy, it’s can be hard to qualify for one. In order to be eligible for a debt consolidation loan that is not only large enough to cover your debts but has a low-interest rate and a term that makes your monthly payments affordable, will require a healthy financial background. Debt consolidation is typically used in the early stages of debt, not after your finances have already been wrecked by debt. Without a good credit score and a decent income, you’ll likely be rejected or qualify for a debt consolidation that has a high-interest rate, which would defeat the whole purpose of consolidating. 

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Some lenders may require you to put up an asset like your house or car before approving you for a debt consolidation. Problem is, if you miss any payments, you may lose your house or car as result. Similarly, if you decide to get a cosigner, your co-signer will be obligated to pay for your debts, which can negatively impact your relationship with them. 

Not Paying Your Card’s Minimum Payment

Consolidating your credit card debt onto one credit card with a lower interest rate is a great way to get back control of your credit card debt and work hard towards paying it off in a reasonable amount of time. There are many things to consider when choosing a balance transfer, but one of the most important ones to remember is that a balance transfer takes time (sometimes up to 2 weeks) to process. This means the period of time it takes for your balance transfer to process you still need to pay at least your minimum payment on any and all of your cards. People often assume that their balance transfer will take effect immediately and when it doesn’t they’re charged late fees because they didn’t bother making a payment to their credit cards. Even after you’re sure that your balance transfer has taken effect you should double check all your balances to verify that you don’t need to make any other payments.

Should you consolidate your debts with a personal loan or a balance transfer?

Taking On Several Loans

If you apply for several loans at the same time it’s going to hurt your credit. Every application for a loan or credit account triggers an inquiry into your credit history and each of those inquiries lowers your credit scores a little bit. Those hits are going to make a big difference on your report, so even though you may be trying to shop around and get a better rate don’t apply for every single one you find.

Continue to shop around; just don’t fill out an application for all the loans you find. Your main goal here is to consolidate your debt, not negatively affect your credit history more than is necessary. Do some research on all the debt consolidation loans that you want to apply for, ask all of your potential lenders about their minimum credit score requirements and then only apply for the loan that you have the best chance of being approved for.

Learn more on how a debt consolidation can affect your credit.

Online Debt Consolidation

Not all online debt consolidation programs are scams but you definitely want to make sure you’re watching out for the ones that are. If you aren’t careful you could end up with a company that isn’t even in the debt consolidation business. You need to make sure that you are looking for a reputable company right from the start. That means you’ll have to do your homework. Don’t just take money from the first lender that offers it to you or the first lender you find.

Learn how to spot a loan scam.

Another important thing to watch for is fees. You should never have to pay money to get money so make sure that you’re watching for this. If any online company says you need to pay them money to review your application or to start the process it’s definitely a scam. Make sure that you never pay any money to someone that’s offering you a debt consolidation loan.

Frequently Asked Questions

How do I consolidate my debts?

There are many ways you can consolidate your debts. You can choose to consolidate using a personal loan, a balance transfer or by tapping into your home equity. You can also choose to consolidate your debts through a debt management program which is typically administered by a credit counsellor. Depending on your financial situation, one option is likely to work better over another. Be sure to compare your options to see which works best for you. 

What are some problems I might face when consolidating my debt with a personal loan? 

Typically qualifying for a personal loan with a low-interest rate and a large enough amount to cover your debts is the biggest problem you’ll face. If you’re unable to qualify for a low-interest rate, then a debt consolidation won’t work as you won’t be saving any money on interest. Moreover, lenders will often require you to provide collateral or have a co-signer in order to be approved. 

Is a balance transfer a good debt consolidation option?

A balance transfer is a good option if the interest rate is low and the introductory period is long enough for you to pay off the debt. If you’re unable to pay off your debt within the low-interest introductory period, you’ll be stuck with a very high-interest rate. It’s also important to consider the balance transfer fees. If the fees negate the savings you’d make from the lower interest rate, it may not be worth consolidating. 

Bottom Line

Debt consolidation is a great way to work on your debt and get yourself back on track when it comes to your personal finances. Consolidating your debt will simplify your payment plan and hopefully reduce your interest rate. If done properly and with the help of a legitimate debt consolidation specialist, it can and will help you pay down your debt and improve and credit history so that in the future your credit will help you and not hinder you.

Caitlin is a graduate of Dawson College and Concordia University and has been working in the personal finance industry for over eight years. She believes that education and knowledge are the two most important factors in the creation of healthy financial habits. She also believes that openly discussing money and credit, and the responsibilities that come with them can lead to better decisions and a greater sense of financial security. One of the main ways she’s built good financial habits is by budgeting and tracking her spending through the YNAB budgeting app. She also automates her savings so she never forgets to put aside a portion of her income into her TFSA. She believes investing and passive income is key to earning financial freedom. She also uses her Aeroplan TD credit card to collect Aeroplan points so that she can save money when she travels.

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