Debt Consolidation using a Line of Credit or Overdraft

If you speak to a certified non-profit credit counsellor for debt consolidation, he/she will give you the option that best works for you. If you qualify, one of the cheapest ways of consolidating your debt in Canada is through a line of credit or an overdraft. With a line of credit or overdraft, the lender gives you a credit card. This allows you to buy your different loans, bills, and other credit card balances and to combine them into one. Lines of credit and overdraft are either unsecured or secured. The amount you qualify for (and whether you qualify at all) depends on:

  • The lending policy of your lender (this changes from time to time depending on how the economy is doing)
  • Your net worth (your assets vis-à-vis your debts)
  • Your credit rating

Lines of credit and overdrafts are different from debt consolidation loans in that you are not given a lump sum. However, just like a normal loan, you have to make minimum monthly repayments.

More specifically, overdrafts allow your bank account balance to go below zero, essentially working as a credit card once your debit account hits zero. On the other hand, lines of credit act as separate credit accounts which you can draw for if you are ever in need of cash

  • You get very low interest rate, especially given the currently low Bank of Canada Prime Rate.
  • Minimal monthly repayments are usually very flexible and you can pay off the loan as fast or as slow as you want. With normal loans, there are penalties for early repayment. Being able to make clear your debt before time and without charges means you will save on interest.
  • You can have an ongoing line of credit where you keep the account open even after your loan consolidation efforts, as long as you remain in good standing with the lender.
  • When you do not have money, you only have to make minimum payments that cover the interest.
  • Lines of credit address the fact that Canadian lenders are not terribly interested in underwriting one-time personal loans, especially unsecured ones, for most customers. It is also uneconomical for borrowers to take out loans every few months, repay them, and then continue the cycle. Lines of credit solve both of these issues by availing money on a needs basis.
  • Negotiating for a line of credit or an overdraft is usually quicker and easier than negotiating for a loan and other debt consolidation options.
  • You only have to pay interest from the moment you access the money, unlike with credit cards where you have to pay interest from the moment you get the card.
  • There is a risk that your debt will never go away if you are not disciplined since the minimum payment only has to cover interest.
  • Interest rates are “floating” or variable. Although the Bank of Canada Prime Rate is low today, nobody can predict what can happen tomorrow.
  • The interest rate of an overdraft, combined with the monthly fee, can be more expensive than the credit card interest rate.
  • Given the high-interest rates of overdrafts, they can just be as burdensome as credit card debt if not managed properly and repaid quickly.
  • Banks have a credit evaluation process, meaning there is a big risk you will not get a line of credit if you have poor credit.
  • In Canada, the interest on lines of credit isn’t tax deductible.
  • Some lenders charge maintenance fee even when you are not using your line of credit, meaning this is an additional cost you have to deal with even when you are not doing debt consolidation.

Applicable Interest Rates

Overdrafts are usually more expensive than traditional lines of credit, mostly because they are unsecured. Banks, credit unions and other lenders typically charge interest in excess of 20%, just like you get with a credit card. You will also pay a monthly fee for the service.

On the other hand, traditional lines of credit are priced based on the Bank of Canada Prime interest rates. The lender then charges an interest rate that is near this Prime Rate (usually +2% of the Prime Rate). Since the Prime Rate has been so low in Canada over the past few years, some banks are charging as low as 1% for their lines of credit. Borrowers with low net worth or credit scores are paying even in excess of 8%.