What is debt consolidation?

Debt consolidation is the process of combining all your debts to allow you to repay with one single payment, often with a better rate or term. This could include borrowing from a bank or other lender to repay your debts, using personal wealth such as an RRSP, or by using a negotiated consolidation.

How does debt consolidation work?

How debt consolidation works will depend on what type of debt consolidation you choose, but any consolidation should provide three basic benefits:

  1. A single monthly payment
  2. A lower overall interest rate
  3. A reasonable repayment timeline

What types of debt consolidations are there?

Negotiated consolidations

(A.K.A. debt management programs) Are non-borrowing solutions commonly administered via a credit counselling agency. Instead of borrowing to repay your debts, your creditors are asked to reduce or eliminate interest while you repay. Unlike debt consolidation loans, negotiated consolidations do not require a credit check and accept all income types.

Debt consolidation loans

Are loans that are borrowed from a bank or other lending institution to repay debt. There are many different types of consolidation loans (see: Types of Consolidation Loans) however all types will require a credit check, proof of income, and will charge some interest.

Self-managed consolidations

Are not ‘true’ consolidations but involve borrowing from your own assets (such as an RRSP or TFSA) to pay your debt, and then self-managing a plan to replace/rebuild the wealth you borrowed from.

Is credit counselling a form of debt consolidation?

Credit counselling is not a form of debt consolidation, it is a debt conversation with an accredited credit counsellor who provides an overview of your money management options. However, credit counselling agencies do offer negotiated consolidations in the form of low-or-no-interest debt management programs.

Pros and cons of debt consolidation

Like any other debt solution, debt consolidation is a tool.

What makes it a good tool vs. a bad tool is the job it needs to do. If consolidation is not the right tool for your job, its ‘pros’ can become ‘cons’ very quickly.

PROS

  • Debt consolidation offers the convenience of a single monthly payment with reduced interest and a more favourable repayment timeline.
  • Consolidating your debt replaces multiple (usually higher) interest rates with a lower single rate that makes it easier to repay your debt.
  • Using debt consolidation as an alternative to filing a consumer proposal or personal bankruptcy can prevent or reduce credit damage.

CONS

  • Depending on the amount of debt you owe you may not be able to afford to consolidate if the resulting monthly payment is too high.
  • Consolidating with the wrong type of lender or with a for-profit debt agency could end up costing more in fees or interest in the long run.
  • Avoiding consumer proposal or bankruptcy when it is genuinely a better option may compromise your financial safety and well-being.

When is debt consolidation assistance the right choice?

Debt consolidation is the right choice if:

  • You could pay your debts in full if interest was reduced
  • You could pay your debts in full if you had more time to repay
  • You could pay your debts in full if you only had one payment

When is debt consolidation NOT the right choice?

You wouldn’t put up a picture with a wrecking ball or demolish a house with a hammer so why would you go bankrupt $500 or try to consolidate $500,000?

Debt consolidation is a ‘hammer level’ solution to debt. If you can consolidate comfortably and affordably, it’s a good option. But the truth is, sometimes you need to knock the whole house down and rebuild on a better foundation.

If you have borrowed more than you could comfortably repay (even with interest relief or a better term) consolidation is likely not the right tool for you.

Types of negotiated consolidations and how to apply:

Negotiated consolidations fall into two main categories: for-profit and non-profit. In both cases this consolidation is called a debt management program.

For-profit debt management programs

Are negotiated by a debt solution company that charges for this service. For-profit programs fees may be charged monthly, upfront, or as a percentage of the debt depending on the company.

Typically, these types of programs target individuals with low or no credit or will be searchable with phrases like ‘bad credit debt consolidation loan Canada’.

Non-profit debt management programs

May also charge a modest monthly fee however most of your program’s costs will be offset by charitable donation.

Will I qualify for a non-profit debt management program?

If what you are looking for is a non-profit debt management program, only two need-based questions asked by your counsellor determine your eligibility:

  1. Do you need help repaying your outstanding debts?
  2. Could you repay your debts fully with interest or term relief?

If the answer is yes to both and your counsellor feels that a debt management program would be both an ethical and affordable option, you’re approved.

What about a for-profit debt management program?

For-profit debt management companies will each have their own in-house requirements for you to qualify. In some cases, this may include a credit check, proof of working income, or an offer of collateral (such as a house or car).

Will ALL debt management programs affect my credit score?

There will be some impact to credit in a debt management program, but it will be less than a consumer proposal or bankruptcy and have a shorter record.

Types of debt consolidation loans and how to apply

Consolidation loans will generally fall into one of four categories of borrowing: unsecured loans, secured loans, high-interest loans, or reverse mortgages.

Unsecured Loans

Unsecured loans are loans that do not need to use property (like a house) as collateral—something your lender could seize if you don’t repay as agreed– for the bank to lend to you.

Secured Loans

Secured loans are loans that use a piece of property or deposit as collateral to give you a loan, such as refinancing a mortgage to access cash or opening a new home line of credit.

High-interest loans

High-interest consolidations are usually offered by finance companies, not banks or credit unions. Rates commonly start at 10% or more but can go as high as 59.99% depending on province.

Reverse mortgage

Reverse mortgages are a unique type of secured loan suitable for older individuals who own their homes outright. A reverse mortgage allows an individual to borrow against their property with no payments required until they either sell or pass away.

How to apply for debt consolidation loans

While every consolidation loan is different (see: Types of Consolidation Loans) as a general rule you will need to meet three borrowing requirements:

  1. Pass a credit check
  2. Provide proof of income
  3. Prove affordability

For secured or unsecured loans, you can apply at any reputable bank or credit union. Secured loans such as second mortgages or home lines of credit can also be borrowed from independent financing companies. For reverse mortgages, you will need to find a lender that specializes in this type of borrowing.

If your credit is damaged, you have a non-working income or are recently self-employed, or cannot afford to repay a new loan, you will require a co-signer.

Debt consolidation assistance and alternatives

If you have been declined for a consolidation loan the next best option is typically a debt management program. However, if neither type of consolidation makes sense or you require a lower payment than consolidation can offer, it is a good idea to review your other options. These options may include:

Debt Settlement

In situations where you cannot reasonably repay all your debt, but you can repay some of your debt AND you have a lump sum available (such as an inheritance or insurance payout) your creditors will often ‘settle’ your debt for less.

Consumer Proposal

In some cases, you cannot reasonably repay all your debt but also you do not have a lump sum available to settle. When required, a consumer proposal can both reduce the amount owed but will also give you up to 5 years to repay.

Bankruptcy

Sometimes repaying your debt—even with a reduction in balance—isn’t an option, and that’s okay! Bankruptcy is a tool that allows us to demolish our ‘financial house’ legally so that we can rebuild on a stronger, better foundation.

How do I know which option is best for me?

Speak to an accredited, non-profit credit counsellor—it’s free, confidential, and it guarantees that you will have the facts needed to make an informed decision.

While some options—like consolidation—are less impactful to credit score, the debt management toolbox contains many different tools for a reason. A credit counsellor can review other key decision-makers with you, such as affordability, effectiveness, future credit goals, and immediate financial need, and they can provide the resources you need to pursue whatever solution you choose.