Here at our LCTaylor office in Winnipeg, we frequently receive phone calls and emails inquiring about “debt consolidation”. Many people have heard about it being a Bankruptcy alternative and believe it may offer a solution to their debt troubles, but the level of knowledge about what it is and how it works varies greatly. Because of this, we thought that a blog answering some frequently asked questions on debt consolidation loans might be helpful.
What is Debt Consolidation?
Debt consolidation is the process of combining multiple debts into fewer debts – ideally into one single debt – as a way to achieve consolidated credit. This is usually done by taking out a new loan or line of credit and using the proceeds from that to pay out multiple existing loans or other credit products that you already have.
Why Do People Do Debt Consolidations?
Debt consolidation has two primary benefits.
The first benefit is that it can simplify your finances. People often have several debts to several different lenders. Each of the debts usually has a different balance and interest rate. Your relationship with each of the lenders is different, and they all want to be paid. You have to juggle who you pay, how much, and when it is due. A debt consolidation can allow you to replace multiple creditors with a single one, which means a single interest rate and due date.
The second benefit is that it can save you money. Ideally, your consolidation loan will have a cheaper interest rate than the credit cards and other debt that you currently have. Having a lower interest rate means that more of your payment will go to the principal of the debt, rather than the interest, allowing you to pay off the debt faster.
Would I Benefit from Debt Consolidation?
This largely depends on how many debts you have and what the rate of interest is on them. If you have high interest debts, on a credit card for instance, and you qualify for a loan at a lower interest rate, then you would benefit from the interest savings. If you have many debts, find it hard to keep track of them all and make the payments on time, then you would benefit from the simplicity of consolidating your debts into a single loan.
What Are Some Pitfalls to Watch Out for With Debt Consolidation?
The biggest potential pitfall of a consolidation loan is that it could lead to an increase in your overall debt if you do not close your current credit products once they are paid off. For example, if you borrow $10,000 from a new loan to pay off five $2,000 credit cards, it is essential that you close those credit cards. If not, you may be tempted to use those credit cards again. Before you know it, you may be back to where you started, with five $2,000 credit cards, but also with a $10,000 “consolidation loan” on top of it. Remember that the goal of a consolidation loan is to make your current debt level more manageable – not to increase your debt level.
Another potential pitfall is the series of lending requirements that some finance companies offering debt consolidation loans put into place. Some of them charge very high rates of interest – perhaps even higher than the debts you are trying to consolidate! The idea of a consolidation loan is to make the debt easier to pay off, but having a higher interest rate will do the opposite and make it harder to pay off.
It is also possible that they will ask you to find a co-signer for the debt consolidation loan. Remember that a co-signer is also legally a co-payer. If you cannot or do not pay the debt for whatever reason, the co-signer is legally required to do so. And this legal requirement is for the entire amount of the debt, not some prorated share. Do you really want to make your debt problem someone else’s problem too?
Where Can I Apply for Debt Consolidation?
Debt consolidation is achieved through a loan from a lender. It may come in the form of a product specifically marketed as a debt consolidation loan, or it might be money borrowed through a more general loan product that you then use to pay off your existing debts. Often, your best bet is to check with the lender(s) that you already owe other significant debts to. Since you already owe them money, they previously decided that you were of a suitably low risk to default on the debt. Whether or not that is still the case, the fact remains that they are already in a position to potentially suffer a loss if your financial position does not improve.
This is different than approaching a new lender, who at that time would have no risk exposure to you. By asking them to give you a loan to consolidate your debts, you are asking them to pay out your other creditors in full, and take on all of the risk that you may not be able to handle your level of debt. Depending on your financial situation, they may not be interested.
What Is a Good Alternative to Debt Consolidation?
Debt consolidation is definitely something to consider, but it is not for everyone. You may not qualify for a loan that will allow you to consolidate your debt, either because of your credit score or other reasons. Even if you do qualify for the loan, it may be on unfavourable terms, such as a high rate of interest and/or with other conditions imposed as mentioned above.
Another possibility is that your debt level is large enough that the required payments on the consolidation loan just aren’t feasible for you. In these situations, a Consumer Proposal may suit your needs.
Similar to a debt consolidation, a Consumer Proposal turns your unsecured debt into a single commitment. This makes it far easier to manage and keep on top of. You can structure your payments however you like, so they can be coordinated with your paydays, the days you receive your pension payments, and/or other days that make the payment as easy as possible for you to make.
An added benefit is that a Consumer Proposal can settle your debts for less than the full amount. After a consultation with a Licensed Insolvency Trustee, an offer will be made to your creditors based on your unique financial circumstances rather than how much you owe. They even come with credit counselling services!
Licensed Insolvency Trustees, such as LCTaylor, are the only professionals that the federal government permits to file Consumer Proposals in Canada. Give us a call at 204-925-6400 or send us an email at questions@lctaylor.net today to find out more.
