Almost everyone today has at least one credit card on hand, access to a line of credit, or the ability to secure a payday loan. When used sparsely, debt is convenient, useful, and enables you to make purchases when cash is scarce. However, using debt habitually can quickly cause your debt level to spiral out of control, and before you know it, you can find yourself unable to make your loan payments. In the most extreme cases, the road ends with bankruptcy and a ruined credit rating that can last years.
Financial institutions, both commercial and nonprofit, have created solutions to relieve individuals’ stress grappling with debt issues. Debt relief programs are designed to help those heavily in debt to reduce their interest rates, negotiate better loan terms, and make timely payments. The two most common ways to improve your debt situation are through debt consolidation and debt management.
Debt Consolidation Loan
A debt consolidation loan is a type of loan that is created from merging multiple loans into a single debt. The process involves taking out one large loan and using the funds to pay off existing loans, leaving only the newly created consolidated loan as a debt obligation. A debt consolidation loan can help you manage your debt payments more easily than if you had to contend with multiple outstanding loans.
In general, debt consolidation loans are created to settle unsecured loans, such as credit cards and payday loans. In some cases, back taxes and student loans are included in the mix. Loans secured with collateral, such as mortgages and car loans, are almost always excluded from debt consolidation loans.
The most common way to consolidate your debt is to obtain a fixed-rate consolidation loan, where you’re assigned a set interest rate and fixed payment schedule. Ideally, the interest rate on the consolidated loan should be lower than your existing loans’ average rate, and you should be comfortable with the payment schedule.
Because a debt consolidation loan is designed to help you pay off your debt faster and with greater ease, your credit score is usually positively impacted. Your credit score may dip slightly at the inception of the loan but recover as you progress through your payment plan.
If you aren’t thrilled with the idea of taking on a large fixed-rate personal loan or have been denied one, you have other options at your disposal for consolidating your debt:
- Home equity line of credit (HELOC) – This loan functions as a second mortgage on your home, allowing you to turn the equity in your property into cash that can be used to pay off your debt.
- Credit card balance transfer – This technique lets you combine the current balances on your credit cards onto one card with a lower interest rate. Some credit cards that specialize in balance transfers even offer a 0% interest rate introductory period.
- Line of credit – You may be eligible to obtain a line of credit from your bank and use it to eliminate your debt. Depending on your risk profile, your bank may ask for collateral.
Advantages And Disadvantages Of A Debt Consolidation Loan
A debt consolidation loan offers both advantages and disadvantages you should carefully examine.
Advantages
- Lower interest rate – You can lock in an interest rate lower than the rates on your existing debt
- Single monthly payment – A single monthly payment will alleviate the stress of keeping track of multiple bills.
- You can pay off your debt faster – A low-interest rate means you’ll accumulate less interest over the life of the loan, enabling you to pay off your debt more quickly.
- No fees – Usually, debt consolidation loans don’t come with extra charges attached.
- Maintain access to credit cards – You’ll be able to utilize your credit cards as you repay the loan.
Disadvantages
- You need a strong credit rating – Financial institutions may not approve your application for a debt consolidation loan if you have a weak credit rating. However, you may still qualify for a debt consolidation loan with bad credit if you apply with a alternative lender.
- You may need collateral – Depending on your lender’s risk tolerance, you may be required to pledge personal property as collateral. If you lack assets, you may be denied your loan.
- You may face a high-interest rate – If you’re deemed a high-risk borrower by top-tier lenders, you could wind up paying a very high-interest rate.
- No discipline imposed – If you’re prone to unbridled spending habits and don’t work to control them, you can easily find yourself in significant debt once again. Debt consolidation loans don’t come with tools to help you create better financial habits.
- No financial guidance or counselling – financial advice and counselling don’t accompany consolidated loans. This may not be ideal if you’re seeking guidance from an expert to help you navigate the loan repayment process while keeping your finances in good order.
Debt Management Program
A debt management program functions similarly to a debt consolidation loan in that it combines your existing unsecured debt into one monthly payment at a lower interest rate. Unlike a debt consolidation loan, a debt management program doesn’t require you to take out a new loan – it’s an arrangement where your existing loans are blended into one repayment plan with a single payment. Debt management programs are structured by credit counselling organizations that operate as nonprofit entities; their goal is to help individuals struggling financially due to excessive personal debt.
You enroll in a debt management program by reaching out to a credit counselling service. Once accepted, you’ll receive a free evaluation of your debt situation as well as a plan on how to tackle it. The agency will work with your creditors to reduce your interest charge and create a customized payment plan that you can manage. In addition to providing you with the predictability and stability of a single payment plan, you’ll also have the support and guidance of a credit expert to help you along the way.
A debt management program can positively affect your credit score once you begin to make consistent payments. However, it may be impacted briefly in a negative way as you are typically required to cancel your existing credit cards.
Advantages And Disadvantages Of A Debt Management Program
Ensure you take the time to familiarize yourself with the advantages and disadvantages of debt management before you decide if it’s the right option for you.
Advantages
- You don’t need a good credit score – A solid credit score is not a qualifying factor for acceptance into a debt management program.
- Access to money coaching and financial resources – Debt management programs are usually supplemented with resources and coaching services to help you improve your financial management skills.
- Flexible – You can stay enrolled in a debt management program for as long as you deem necessary and can cancel your participation anytime.
- Low-interest rates and low fees – Lenders are keen on offering credit counselling agencies low-interest rates and waiving fees to help consumers pay their loans.
Disadvantages
- You’ll have to be disciplined with your payments – If you miss a payment, the deal the credit counselling agency negotiated on your behalf with your creditors could be revoked.
- Lost access to credit cards – You’re required to close all of your credit cards and only rely on credit for emergency use.
Main Differences Between Debt Consolidation and Debt Management
| Debt Consolidation Loan | Debt Management Plan | |
| Debt Amount | $1000 – $50,000 | $5,000 + (no limit) |
| Interest rate | 8% – 28% | 0 – 10% |
| Time to payoff | 24-60 months | 36 – 60 months |
| Credit score required | Usually, 650 or higher | No minimum credit score required |
| Debts you can include | Unsecured debt, sometimes back taxes and student loans | Unsecured debt, mostly credit cards |
| Credit card restrictions | None | Your credit cards will be closed, though you may have one for emergency use |
| Credit score impact | Neutral or positive but can cause a temporary dip. | Neutral or positive but can cause a temporary dip. |
Should You Opt For Debt Consolidation Or Debt Management?
A debt consolidation loan is an ideal option if:
- You qualify for a low-interest rate that can help you save money over the long run.
- You want to cut down the number of loans you’re paying.
- Your total debt load is not excessive.
- You want to preserve access to credit while repaying the consolidated loan.
A debt management program is an ideal option if:
- Your debt is mostly on credit cards.
- You’re carrying a very high level of debt.
- You have a poor credit score.
- You’re looking for financial coaching and advice.
Debt Relief FAQs
Can I get rejected for a debt management program?
Do I need to provide collateral for a debt consolidation loan?
Where can I get a debt consolidation loan?
Bottom Line
Debt consolidation and debt management are both excellent avenues to explore to get your debt under control. Both solutions have their pros and cons, so it’s imperative to do your research to determine which one is most suitable for you.
If your total debt load is not excessive, you’re not tied to high-interest rates, and you have decent credit, a debt consolidation loan may be the best option for you. Conversely, if your debt load is massive, mostly comprised of high-interest credit cards, and your overall financial situation is dire, a debt management program is likely the superior choice.
Looking For Debt Relief?
If you’re currently struggling to manage your debt, Loans Canada can help by matching you with the right debt relied service based on your unique needs.
