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Is Debt Consolidation Right for You?

19 October 2018 by National Bank
debt consolidation

Having a considerable amount of debt raises your risk of being in payment default and, as a result, can tarnish your credit report. To help repay your debts, consolidation could be an interesting solution for you.

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Debt consolidation involves putting your debt in one place so that you make one payment per month. Generally offered at a more advantageous rate than credit cards, loans approved for consolidation also allow you to reduce your monthly payment.

According to the Government of Canada’s Office of Consumer Affairs, debts eligible for consolidation include, but are not limited to, credit cards and lines of credit, utilities and other loans related to consumer goods. Note that mortgage loans cannot be included in a consolidation loan. Check with your financial institution to learn more about eligible debts.

Who can carry out debt consolidation?

Are you wondering if your financial situation could benefit from debt consolidation? Here is a concrete example of how this solution can help someone regain control of their finances. Annie is a 30-year-old professional who has accumulated $20,000 in various debts, primarily from credit cards and student loans. Most of the time, she manages to pay the minimum amount required—however, she feels like she will never get out of the hole. She believes she may have to resort to a consumer proposal and try to work out an arrangement with her creditors. She is even considering filing for bankruptcy. During a meeting with a financial advisor, debt consolidation was brought up as an option.

According to Mr. Éric Lebel, a recovery advisor and partner at Raymond Chabot Grant Thornton, debt consolidation is an option for those who have a good credit report. “Before thinking about debt consolidation, it’s important to ensure that you are solvent,” he says.

Solvency, or insolvency, is the ability or inability of a person to pay their bills and debts when they are due. In his work, Lebel meets many people who hope to establish a consolidation agreement with a financial institution. “It’s sometimes their last hope,” he says.

How to request debt consolidation

The bank will evaluate the risk you represent before any other steps are taken. They will examine your credit report, debt ratio, repayment behaviour and your ability to pay off your loans. “If the bank feels that you would have trouble repaying other creditors, they may not grant you the loan,” says Lebel.

It may happen that the banks require a guarantee through an endorser. “If, for example, you have a good job and equity on your home, you could be a good candidate, depending on the amount of debt you have to consolidate,” he explains.

Are you able to repay your debts?

To find out if debt consolidation is a winning solution for you, you can start by evaluating your ability to pay the required loan for all of your debts. “Say you have $20,000 in debt from bank and department store credit cards, with rates of 19% and 29%. By consolidating these debts, even at a rate of 12%, both your monthly payment and the amount of interest paid at the end of the term will be lower. So it really is beneficial for you,” says Lebel. Paying less interest each month allows you to get your finances in order by repaying more capital.

Cost of credit cards (average rate 24%)
Cost of debt consolidation (rate 12%)
Balance
$20,000
$20,000
Payment
Approximately $500/month (minimum required to cover capital and interest)
$445/month
Repayment time (estimate)
6 years and 10 months
5 years
Interest paid at the end of the term
$20,637.97
$6,693.40

Example from Raymond Chabot Grant Thornton.

If you are having financial difficulties and are not eligible for debt consolidation, you can request a second chance credit. Conscientiously repaying this loan every month will rebuild your credit report and increase your chances of being able to obtain a traditional loan or consolidate your debts.

What should you know before consolidating your debts?

If your credit report allows you to obtain this type of loan, here’s how you can benefit from it:

  • One single payment.
  • An interest rate generally lower than that of credit cards.
  • Your monthly payment is lower than if you repaid each debt individually.
  • At maturity (maximum period of 5 years), you will have paid back all of your debts. The term is generally shorter than the term for credit card repayment with a higher interest rate.
  • Your credit report remains intact.
  • By consolidating, overall debt remains the same, contrary to a consumer proposal. Even after consolidating the balance of your credit cards, remember that the amount of debt to repay will increase if you continue to use them.

    For Lebel, there are few consequences involved in debt consolidation. “On the other hand, finding a bank that will lend you money to repay other banks or creditors will be easier if you do not have financial difficulties,” he says.

    It’s never too early or too late to take control of your finances. Take the time to review your financial habits and ensure that you are on the right path to achieve your goals. In case of any doubt, your financial advisor is there to assist you.

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