What is Debt Consolidation in Canada?

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The process of debt consolidation, as a solution to your financial challenges, is designed to help you manage your debts. It is crucial to fully understand how it works before determining if it’s meant for you or not.

If you are struggling with your finances, it may comfort you to know that you are not alone in this. TransUnion predicts the average Canadian’s non-mortgage debt might see an increase of 1 per cent to $31,531 by the end of 2020. It pointed out an first time occurrence of outstanding credit card balances in Canada exceeding $100 billion in the third quarter.

What is Debt Consolidation?

Debt consolidation is a debt refinancing program in which you take a loan to offset many other loans or debts. It is a process of combining multiple debts into a single debt with lower interest payments, which can eventually lead to a quick debt offset.

That is, obtaining a substantial loan to offset several small loans, bills, or debts that are currently being paid, and combining them to form one manageable loan with a single monthly payment.

Debt consolidation loans take care of your credit card debts, payday loans, unsecured credits, overdraft balances, bills, and credit card balances.

How Debt Consolidation Works

Debt consolidation involves the combination of two or more debts into one manageable debt. However, not all debts can be consolidated or merged the same way, and that is why there are debt consolidation loans you can take to offset your debts; and debt consolidation programs you can sign up to that will help you manage your debt payment.

Debt Consolidation Loan

This is usually a process of taking a loan to offset all your debts. The way it works is that you take a large loan to pay off all your small loans so that you only focus on paying back the massive loan.

In doing this, you must have a good credit score. You must ensure to get a loan that will help your debt situation, not the one that will compound your woes.

Debt Consolidation Program

This is an agreement entered into with a credit counselor, who will arrange with your creditors on modalities for payment of your unsecured debts. The credit counselor will guide you to organize your debts, set new goals for your finances, rebuild your credit, manage your expenses, create an emergency fund, and develop a personal budget.

These measures will help to offset your debts and live a debt-free life quickly. It would help if you were careful in choosing a debt consolidation program, as there are some unscrupulous agencies taking advantage of stressful conditions.

Reasons for Debt Consolidation

A lot of people get debt consolidation for several reasons, some of which are:

  • To pay off debts faster.
  • To eliminate and offset high-interest loans.
  • To offset credit card debts.
  • To simplify finances into a single payment system compared to multiple debt settlements.

How to consolidate your debts

There are several factors to consider in deciding which method to choose in consolidating your debts.

However, one salient factor is identifying your type of debt and what each requires in terms of the interest rate, the total amount owed, and the monthly repayment amount.

After doing this, you need to consider the method to use in consolidating your debts, some of which are:

  1. Debt Consolidation with a Mortgage

One way to consolidate your debt if you have a mortgage is through your home equity. This involves taking a second mortgage or refinance. Mortgage interest rates are much lower than other loans and can be paid off over a long period.

2. Debt Consolidation Loans (Secured and Unsecured)

If you have a good credit score and collateral, you could check if your bank or credit union can offer you a debt consolidation loan. Banks and credit unions offer unsecured loans but not more than 10 percent of your net worth.

For instance, if your net worth is $23,000, you are likely to get a $2300 unsecured loan. However, if you need a loan that exceeds your 10% net worth, the bank will require some security (collateral) for the loan. This could be your vehicle, investment accounts, pieces of jewelry, etc.

  1. Debt Consolidation Program: You can use the service of a credit counselor to help you manage your debts. This might lead to a reduction in interest rate by your creditors. They may also help you in organizing your finances.
  2. Loans from Family and Friends: There are situations that your bank or credit union cannot rescue you from your financial debts. In such a case, you can turn to your family, associates, or friends, if they can lend you the money for your debt consolidation. However, this is risky and could lead to a bitter relationship if you cannot pay back at the time as agreed. So, if you can secure a loan from a family or associate, make sure you honor the terms of the loan as most of these loans have 0% interest.
  3. Personal Budget and Savings: Another way to consolidate your debt is to increase your income and manage your expenses. Selling some assets, taking another job, personal savings, cutting out expensive lifestyle and hobbies, are some of the ways to augment your income, and cut your expenses. With this, you can save money to pay off your debts quickly.

Factors to consider before signing up to a Debt Consolidation Program

Before you sign you for a debt consolidation program, here are some of the things to check.

  1. Make inquiries about their fees, which should not be more than what you can easily afford. The aim is to get out of debt, not acquire even more debt.
  2. Ensure that the company or agency is a non-profit credit counseling agency.
  3. Check for their ratings on Better Business Bureau (BBB) for honest practices and do proper research on the company’s reputation.
  4. Enquire about their accreditations, which must meet the standards stipulated by the Association for Financial Counseling and Planning Education (AFCPE) and Credit Counseling Canada (CCC).

How Debt Consolidation Affects Your Credit Score

While trying to consolidate your debts, it is essential to make sure it does not hurt your overall credit ratings.

  • A debt consolidation loan will more than likely improve your credit score in that you are using the loan in paying off your credit card debts.
  • A debt consolidation program will also show that you are making regular payments to settle your debts, which should help your credit rating.

Debt consolidation is an affordable one time or single monthly payment with its ups and downs. You should carefully consider your options before deciding which step to take.

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Kareena Maya is a freelance writer focused on the personal finance and travel spaces. He frequently writes about credit cards, banking, student loans, insurance, travel rewards and more. His work has been featured in publications such as Forbes Advisor, Bankrate, Credit Karma, Finance Buzz, The Ascent and Student Loan Planner.

Kareena Maya is a freelance writer focused on the personal finance and travel spaces. He frequently writes about credit cards, banking, student loans, insurance, travel rewards and more. His work has been featured in publications such as Forbes Advisor, Bankrate, Credit Karma, Finance Buzz, The Ascent and Student Loan Planner.