Debt Consolidation: Is It Worth It? When?

Understanding the Ins and Outs of Debt Consolidation Loans—And Why They Might Not Be Your Best Bet

Are you frustrated with constant debt, and do you struggle to pay it off month-to-month?

There are many solutions out there that could help you through your debt crisis, including debt consolidation loans.

A debt consolidation loan helps you pay off your outstanding debts quickly while reducing your monthly interest payments.

Still, these loans aren’t necessarily a good fit for everyone; depending on your situation, a debt consolidation loan could be a way forward, but it could equally be yet another challenge for you to overcome.

This begs the questions: is debt consolidation worth it? And if so, when?

Here’s what you need to know.

What Is Debt Consolidation?

When you get a debt consolidation loan, you are borrowing money to pay off other debts.

As the name suggests, you’re consolidating all your debts into a single lump sum that you pay off immediately.

You’re left with your previous debts erased, but now you’re in debt to your lender and need to pay them back.

In some cases, you can use home equity to consolidate debt. Home equity is the sum left over when you subtract what you still owe on your mortgage from your home’s overall worth. Some homeowners who’ve built up enough equity in their home can use this equity to consolidate their debts.

If you go the route of a standard debt consolidation loan, you can expect loan terms between 3 and 7 years.

There’s a common belief that a debt consolidation loan will have better interest rates than your existing debts; while it’s not impossible, it’s unfortunately not that straightforward. Your new interest rate will be determined (by and large) by two factors: your credit score and the collateral you offer.

The big takeaway here? Debt consolidation doesn’t wipe out debt entirely, it just replaces multiple debts with a single debt. This can make repayment easier—but not always.

These loans can also be compared to a debt management plan, which doesn’t consolidate your loans but individually negotiates lower rates and better terms for them.

Is Debt Consolidation A Good Fit for My Situation?

The short answer? It depends.

The long answer? …it still depends!

Yes, a debt consolidation loan can greatly simplify your payments.

If you’re paying down many high interest accounts, a debt consolidation loan can get you back on track. You will be completely debt free once you pay back the loan, and your original creditors are paid back immediately.

As a bonus, your credit score will usually go up, because your accounts will all show up as paid off.

However, there are a few situations in which a debt consolidation may not help. If you still wouldn’t be able to pay your adjusted payment amounts, a consumer proposal is likely a better option.

If you have bad credit, you may not be able to qualify for a consolidation loan without a co-signer. And if you can’t make your new, consolidated payments, you could end up damaging both your credit and a co-signer’s.

When Is a Debt Consolidation Loan a Good Idea?

Due to their nature, debt consolidation loans are best for high levels of credit card debt or personal loan debt.

Credit card debt can often have interest rates above 20%. Debt consolidation loans can save you from dealing with steep interest rates if you’re already struggling with significant debt.

As such, if you’re already enjoying relatively low interest rates, debt consolidation probably isn’t a good fit. In these situations, it’s worth exploring your options with a financial expert, such as a Licensed Insolvency Trustee.

How Do I Qualify for Debt Consolidation Loans? What Are Banks Looking For?

Getting a debt consolidation loan is very similar to getting any personal, unsecured loan. You need to have at least a moderately high credit rating or a co-signer, so it’s best to get a consolidation at the first sign that you can’t feasibly pay your current debts.

You will also need to be able to show that you have stable regular income and that your debt-to-income ratio is within the allowed limits of the consolidation program.

If you cannot pay the revised amount of your debt, then you’ll likely be denied for a loan.

How Does Debt Consolidation Affect My Credit Score/Rating?

A debt consolidation loan, in and of itself, does not directly impact credit scoring.

That said, debt consolidation can positively impact your score in a roundabout way. After all, you’re paying off your credit accounts quickly; provided you keep them in good standing, you should be able to maintain or improve your credit rating.

When you first apply for a debt consolidation loan, you may see your credit score temporarily take a hit. This is because any loan that you apply for is going to create a “pull” on your credit, and a credit pull usually reduces your score by a few points.

What Should I Watch Out For?

There are debt management companies that are willing to take your money for a consultation only to reveal they can’t actually help you.

When searching for help with your debt woes, look for regulated professionals, such as Licensed Insolvency Trustees. Ask to see a schedule of fees, if applicable, before you sign anything. Take time to review your debt professionals online, watching for testimonials and negative feedback.

Your best bet will always be a professional with a clear mandate and regulatory body. Consultations should be a courtesy, and they’ll be able to help you determine what the best way out of your debt crisis will be, and even recommend alternatives to consolidation and bankruptcy.

Contacting a Licensed Insolvency Trustee is a good first step towards getting control of your financial situation. A Licensed Insolvency Trustee will be able to review your financial situation, suggest the right measures to take control over it, and plan out your consumer proposal to get out of debt.

If you are overwhelmed with debt, and your credit rating is low, or you expect it to plummet due to having an account sent to collections, or the garnishment of your pay, it is highly possible that the best thing you can do is to file a consumer proposal. A consumer proposal is a debt and money management plan overseen by a federally licensed and regulated professional. Consumer proposals stop collections, garnishments, collect lawsuits and accruing interest. A single and affordable monthly payment is required, and you will be debt free in 5 years or less. Principal reductions to 20% to 40% of the amounts owed are very common. The filing of a consumer proposal will give you a fresh start on building a good credit score.

Baker Tilly Ottawa Ltd. is a Licensed Insolvency Trustee servicing Ottawa, Gatineau and eastern Ontario since 2002. Its licensed professionals have over 100 years of combined experience in assisting individuals in financial difficulty. They have overseen thousands of successful consumer proposals. Their passion – their mission – is your health and well being! Start your journey today with a free initial consultation!