Debt Consolidation using a Debt Consolidation Loan

Debt consolidation allows you to merge several smaller loans, credit card balances, payday loans, overdraft balances, bills, and debts into one. Note that in reality, it is technically impossible to combine different loans since each loan has its own repayment terms and interest rate. So to consolidate a debt involves getting a new, larger loan and using the money to pay off the smaller loans that you wish to consolidate.There are many sources of loans to do debt consolidation, one of the most popular being debt consolidation loans.

  • Since you only have one loan to repay at the end of the month, there is a reduced risk of making a late repayment. Having only one loan to deal with is convenient and it gives you peace of mind.
  • Most lenders offer debt consolidation loans at a lower interest rate compared to what you are paying with the smaller loans (especially credit card debt), meaning you get to save money.
  • There are timelines when you have to pay off the loan (typically 2 to 5 years), meaning you are better able to plan your future.
  • The applicable fees when getting a debt consolidation loan are usually very low.
  • Debt consolidation does not negatively affect your credit rating. There is actually a good chance your credit rating will improve since with reduced interest payments means you are more likely to meet your obligations.
  • With most lenders, you have to provide some form of collateral to qualify for the loan. This means a lien against your household furnishings or car or a second mortgage on your house. If you are unable to meet your monthly obligations, you risk losing a lot.
  • Even if you will be paying lower interest, combining old debts still leaves you with a large monthly repayment. If you were struggling with 5 small loans, you will still struggle with 1 large loan.
  • There is a risk that you will fall even further into debt if you consolidate your loans and you still have access to your old credit cards.
  • Most lenders require that you have a good credit score, meaning this is not a viable option if you don’t.
  • Home equity loans (refinancing your home) give you a lower interest rate.
  • If don’t have collateral, the interest rate for debt consolidation loans can be as high as 30%.

Interest Rates in Debt Consolidation Loans

In Canada, you can get the best debt consolidation loan interest rates from banks and credit unions. Lenders set interest rates on a case-by-case basis. Some of the factors affecting interest rates include:

  • Your credit score
  • Whether you have an existing relationship
  • Whether or not you can provide good collateral, some of the best collateral being non-RRSP deposits, new model vehicles, boats, and other assets that are easy to liquidate or sell.
  • Your net worth (your assets should be higher than your debts for unsecured debt consolidation loans)
  • Availability of a high net worth co-signer (for debt consolidation loans)

Over the past 10 years, debt consolidation loans have typically attracted an interest rate of between 7% and 12% while finance companies have been charging an average of 14% and more than 30% for secured loans and unsecured loans respectively.

What it takes to secure a Debt Consolidation Loan

Banks have several minimum requirements that you have to meet to get a debt consolidation loan. These include:

  • You must not have made too many late payments of the debts you want to consolidate
  • You must not have a big negative on your credit report
  • Your income must be enough to support the monthly repayments
  • You must provide good collateral in case you are unable to fulfill your obligations

Note you may still get the loan even if you do not fulfill all the requirements. A good co-signer will assist you to secure a loan since he/she will be responsible for clearing the loan if you are unable to.

If you do not qualify for a debt consolidation loan due to such reasons as unavailability of reasonable collateral, there are other options available. Most of these solutions are a little complex and you may want to talk to a Credit Counsellor to know what best works for you. Non-profit Credit Counsellors offer their services free of charge. No matter how desperate or complicated your situation may seem, do not despair – there is a solution for everyone.