Know what you are signing up for.
If you Google “debt consolidation”, you’ll come up with a variety of possibilities:
- Banks and credit unions offering debt consolidation loans.
- Finance companies offering debt consolidation loans for high-risk customers – at a higher interest rate, of course.
- Credit counselling agencies offering credit consolidation through a debt management plan.
- Companies that offer debt consolidation, debt negotiation or debt settlement services.
- Licensed Insolvency Trustees who can help you consolidate and settle your debts using a consumer proposal.
That’s a lot of confusing terminology. So how do you know who is offering what and which is the best option for your unique situation? To begin, we will start with a basic definition of each type of debt consolidation service available in Canada.
Debt Consolidation Loan
A traditional debt consolidation loan means you are taking out one loan and using the proceeds to pay off several smaller loans. They are usually offered by a bank or other financial institution. You pay off 100% of your debt, plus interest on the new loan, and sometimes you are also charged a loan application fee. A good example would be taking out a second mortgage on your home to pay off your credit card debts.
Debt Management Plan
This is a repayment arrangement made between you and your creditors with the help of a credit counselling agency. You pay back 100% of what you owe but often avoid having to pay interest.
This is a formal debt settlement program under the Bankruptcy And Insolvency Act offered through a Licensed Insolvency Trustee. You pay back less than the full amount that you owe. While settlements of 30% are common, the exact settlement rate depends on your income and what you own.
While a debt management plan and a consumer proposal are technically types of debt settlements because you negotiate an agreement with your creditors, debt settlement can also refer to services provided by unregistered debt consultants.
In many cases, these companies charge you high up-front fees, pressure you to sign difficult-to-understand contracts, provide misleading information about how your credit rating will be affected and claim that they are somehow connected to the Canadian government.
In other instances, they charge an up-front fee to discuss your situation with you, only to refer you to a trustee to file a consumer proposal.
According to the Credit Counselling Society, the success rate for these for-profit debt settlement companies is under 10%, and 65% of the people who pay fees to them leave their programs without settling their debt.
Because we generally do not recommend non-accredited debt settlement programs due to their inherent danger, our next chapters will focus on the three most common forms of debt consolidation: debt consolidation loans, debt management plans and consumer proposals. We will look at how each option works, run some numbers to help you see how each solution could affect you financially and take a look at the pros and cons of each alternative.