Reasons Consolidating Your Debts May or May Not Be the Right Solution
Canadians have several options to pursue when it seems their debt is beginning to spiral out of control. The most moderate of these is debt consolidation. It may seem like an ideal solution, but there are both pros and cons to this approach.
What Is Debt Consolidation?
Debt consolidation means you combine all or most of your unsecured debts (like credit cards and personal loans, but not mortgages or car loans) into one single loan or line of credit.
Benefits of Consolidation
There are several benefits of debt consolidation. First, you now only have one debt payment to make each month, instead of having to keep track of multiple payments. Second, if you’ve done your homework on consolidation loans, your monthly interest charges should be much lower than they were on your credit cards and other debts. Consolidation loans also typically have fixed repayment periods, so you’ll know how much is due each month. Plus, you may be able to pay off your debt faster and improve your credit rating if you make all your payments on time.
Are There Different Types?
There are several different ways to consolidate debt, including various types of loans and lines of credit. These products may be secured or unsecured, depending on your financial situation and what you can get approved for.
A secured consolidation loan means you’re putting your assets on the line as an assurance that you will pay back the loan. It may take the form of a home equity line of credit (HELOC) or a loan that uses your car or other asset as collateral.
Unsecured consolidation loans include personal loans or lines of credit. These loans don’t require any collateral—they rely on your word and your credit rating to assure their repayment.
Downsides to Debt Consolidation
Although a consolidation loan may seem like the answer to all your debt problems, they aren’t a cure-all. Here are some of the downsides to consolidating your debt:
You’re Not Reducing Your Debts
Your debt doesn’t go away with a consolidation—the debts are combined into one loan. If you’re in debt to the point where you can’t afford to even make payments anymore, a debt consolidation won’t help. You will still owe the exact same amount of principal.
It Can Be Expensive
If you choose to consolidate make sure you understand the terms of the loans, including the interest rate charged and the length of time to pay off the loan to determine the amount of interest you are paying over the period of the loan. Also, be aware of any fees you may be charged, in addition to interest. If you choose to take out a personal loan for consolidation, the longer the term of the loan, the higher the interest rates, so you may end up paying even more interest than you would have on your original debts.
It’s a Band-Aid Solution
If you’re in enough debt to consider a consolidation loan in the first place, chances are good that your spending habits are high-risk. Even if you begin repaying your debts after consolidation, you may find yourself making some common mistakes, like running up new debt on credit cards once they are paid off, or continuing to live beyond your means. Debt consolidation is just one part of building a healthy financial life. You need to rethink your spending and saving habits as well.
Secured Loans Put Property At Risk
If you cannot pay off a secured loan that uses your home as collateral, the lender can, and likely will, seize your home and sell it to recoup its loan. Same for a loan that uses your car or other assets as collateral. So, don’t take on a secured consolidation loan unless you’re certain you can repay it on time.
Secured Loans Don’t Get Discharged With Bankruptcy or a Consumer Proposal
If you use a secured loan to consolidate your debts, and later file for bankruptcy or a consumer proposal, be aware that secured debts are not discharged by these debt relief methods. You’ll still be on the hook to repay them even after you go bankrupt or complete a consumer proposal.
Other Debt Relief Solutions
If the cons to debt consolidation outweigh the pros, but you still need help dealing with your debts, consider consulting with a Licensed Insolvency Trustee (LIT) to review the other options available.
A consumer proposal is a negotiated agreement with your creditors where they agree to forgive a portion of your debt, interest free and you agree to pay off the remaining portion within a specific timeframe. Your LIT helps to set up the proposal and determines the payment amount and term that’s right for your budget. Under a consumer proposal, your assets are not seized, but your credit rating does take a hit.
If you aren’t sure what your next steps should be, consider signing up for credit counselling. A trained professional will help you assess your finances honestly and without judgment, offer clear and insightful advice, and assist you in making a concrete plan to get your debt under control and manage your finances, so you can stay out of debt in the future.
Bankruptcy should be your final option, in cases where your debt is too overwhelming and you don’t have the income or means to pay it off. Most of your assets will be seized and sold to pay off your debts, and your credit score will drop to the lowest possible rating. But in return, once you are discharged, all your unsecured debts are wiped out and you can make a fresh start.
Debt consolidation is one way to get a handle on debt that’s beginning to feel frightening, but it may or may not be the right solution for your financial situation. Before you decide what to do, consider talking with a professional. Our team at Baker Tilly is here to answer your questions about debt and financial health.
Baker Tilly Ottawa Ltd. is a Licensed Insolvency Trustee based in Ottawa. We service Ottawa and most of eastern Ontario. We have helped thousands of individuals and couples successfully resolve their debt challenges since 2002. Its passion – its mission – is your health and well-being!