Whether you are refinancing, consolidating your debt or looking for a new loan, there are many credit products in the market today to choose from. Like any loan, debt consolidation loans can differ in terms of interest rates, fees, payment schedules and flexibility. What type of debt consolidation product you choose will depend upon balancing your needs with your credit capacity and your risk tolerance.
Refinancing with a Second Mortgage
Credit Capacity: If you have some equity in your home, you may find you have more choice in terms of lenders willing to consolidate your debts. Of course this will depend on other factors including your income and overall debt levels, but all things being equal, most financial institutions will consider lending to someone with more than 20% equity in their home.
Benefits: You can achieve lower monthly payments because you can usually negotiate a lower interest rate and extend the term of your loan. However, the longer you take to repay your loan, the more you will pay in interest.
Risks: If you cannot keep up with your payments you risk losing your home. It is also possible you may not have enough equity in your home to consolidate all of your current debts. If, after consolidating, you continue to use credit cards without managing your finances, you run the risk of building more unsecured debts on top of those you consolidated.
If you are considering using the equity in your home to consolidate credit card debt and you don’t think you can afford the payments or it will not take care of all of your debt problems, talk to an expert about filing a consumer proposal instead. This allows you to use the equity in your home to settle your debt, rather than risk your home by moving money around.
Consolidating with A Line of Credit
Credit capacity: To qualify for a secured line of credit you will need a fairly good credit rating or may need to offer collateral. This is because the credit line is available to you all the time. You may pay it down, but can always redraw the balance if needed.
Benefits: There are two benefits of using a line of credit. Payments can be interest only, or with a nominal principal repayment requirement, so are very affordable. In addition, any unused balance on your line of credit can work as a form on emergency fund while you are using all the cash you have to pay down debt.
Risks: If you provide collateral and cannot keep up with your payments, you risk losing that asset. Interest rates are typically variable and can increase and if you can’t afford the higher payment you risk default. The greatest risk however is that, without commitment, you will never repay your debt.
If your minimum payments take up a significant portion of your income and you do not think you will be able to repay your line of credit within a reasonable period, consider your other options.
Consolidating with a Term Loan
It’s also possible to apply for a debt consolidation loan tied to a fixed interest rate and predetermined repayment term, much like a car loan. This can be 3 years, 5 years or more.
Credit capacity: Your credit score will affect who will be willing to approve your debt consolidation loan, the interest rate and fees. You may also be asked to provide collateral or a co-signer if you have poor credit. Unsecured debt consolidation loans are usually only available through alternate lenders including finance companies and debt consolidation companies.
Benefits: Costs are usually lower than high interest credit cards. You have one fixed monthly payment which provides some certainty in your budgeting.
Risks: Finance companies or debt consolidation companies for bad credit borrowers may be willing to loan you money but they will charge higher interest, and often come with significant application, cancellation and late or missed payment fees that can prove costly.
If you have bad credit, and are considering a high interest rate debt consolidation loan, you should consider non-loan options to consolidating your debt including a debt management plan or a consumer proposal.
Debt Management Plan
Payment capacity: You are not applying for a new loan when you arrange a debt management plan through a credit counselling agency so your credit score is not the determining factor. Instead, your credit counsellor will look at how much you can afford to pay each month towards your debt and whether or not this will repay your debts in full within 5 years.
Benefits: There is usually no interest during the debt management period so this can be a truly low cost option to repay your debt.
Risks: A debt management plan is an informal repayment arrangement. Given that, it is important that you make sure you are dealing with an accredited credit counsellor and that your payment terms are agreed to by your creditors up front. If you cannot afford your payments and cannot repay your debts in full you creditors can continue to pursue through legal means such as a wage garnishment.
Payment capacity: If you cannot afford to pay your debts in full, a consumer proposal is a process that allows you repay a percentage of your debts. Your monthly payments are again based on what you can afford to pay, not based on how large your original debts.
Benefits: With no interest, and a reduced principal repayment, a consumer proposal usually results in the lowest monthly payment. Since a consumer proposal is filed under the Bankruptcy and Insolvency Act it also provides protection from creditor actions like a wage garnishment.
Risks: The proposal must initially be accepted by your creditors and you must be able to complete all agreed payments in order for your original debts to be eliminated.
If you need help deciding what type of loan you should consider, or even wonder if a debt consolidation loan is the best option for you, contact one of our debt management experts. All consultations are free, with no obligation. By reviewing your situation they can help you make the right choice for your finances.