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Debt consolidation can be a helpful tool when it comes to dealing with debt, but the reasons why someone might want to consolidate can vary from needing simplified payments, wanting to save money or needing to improve their credit rating.
Juggling multiple debts can be stressful, especially if your budget is already stretched to the max since it may involve figuring out which bills to pay this month and which to pay next month.
There are two general types of debt consolidation: consolidating your debts and consolidating your payments. Some options require borrowing more money, while others make do with what you have or help you take the necessary legal steps to absolve yourself of all or part of your obligations. The right option will also help you address your underlying debt or money problems.
A debt-consolidation loan is what first comes to mind for most people. It ticks a lot of the boxes: one payment instead of several, lower interest to save money and if paid as agreed, it can help improve your credit rating. If you qualify, it wipes the slate clean and takes away the stress. However, borrowing more money when you’re trying to pay off what you already owe is only a good strategy if you also have a rock-solid budget to help you spend within your means.
Before taking on a loan to pay off your debts, prove to yourself that you can live according to a budget by doing it for two or three months. On top of sticking to what you had planned to spend each time you get paid, it means saving towards Christmas and birthday presents, new school clothes or an emergency car repair bill.
The accounts you’re paying off with a debt-consolidation loan typically get closed. If you reopen them, or apply for new credit accounts — for example, a credit card — you could end up doubling your debt if you go back to relying on credit to make ends meet.
There are some DIY debt-consolidation options that are akin to trying to borrow your way out of debt. A popular, but not typically effective option is using a credit card to transfer balances and consolidate your debts on one card. If you are disciplined with how you pay off the new, bigger balance on one credit card, this strategy could work for you, but credit-card balance transfers are a hard way to pay off consolidated debt.
The revolving nature of a credit card makes it tempting to continue spending. Furthermore, if you take advantage of a promotion or low introductory interest rate, you’ll need to calculate whether you can pay off what you owe during that promotional time. If it will take you longer, the post-promotion interest rate and fees are typically much higher.
For example, let’s say you want to use a low-interest credit-card transfer promotion to pay off the $10,000 you owe on your overdraft and two other credit cards. The promotion is that you’ll only have to pay three per cent on the portion of your balance that you transfer over for seven months. The interest each month will be about $25, but the monthly payment to clear up the $10,000 before the promotional period ends will be about $1,430.
Before you enter this arrangement, ensure your budget can accommodate a payment of $1,455 per month for the seven-month period. If that’s not affordable — and it likely isn’t — look elsewhere for a debt-consolidation option.
If borrowing money to combine multiple debts isn’t possible, combining just your payments might be. There are two options to do this: one is a debt-repayment program through a not-for-profit credit counselling agency and the other is a consumer proposal facilitated by an insolvency trustee. Both programs mean having one payment going forward for your unsecured debts.
However, if you would prefer to keep your financial situation private, explore the debt-repayment program option first. A credit counsellor will review your income and obligations with you during a confidential appointment. Based on your budget, they will recommend either a debt-repayment program, consumer proposal or a different option entirely.
A debt-repayment program is a voluntary arrangement facilitated by your credit counsellor between you and your creditors to repay what you owe and hopefully learn some money skills along the way. Creditors typically support the program by waiving or drastically reducing the interest you pay while on the program. The typical program lasts 3.5 to four years, after which there is support available to start rebuilding your credit rating.
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A consumer proposal is a legal arrangement to repay a portion of what you owe. Creditors holding the majority of your debt must agree to the proposal, which is facilitated by an insolvency trustee. Once your proposal is agreed upon, it is registered with the courts and payments are made through your trustee.
Before you determine which debt-consolidation option is best for you, do your research to find out about all of them. Your budget will play a big role in the process, so be sure to nail one down first. Depending on the type of debts you have, your ability to make payments, your money habits and your future goals, one option will ultimately be your best strategy to get out of debt and keep it that way.
Sandra Fry is a Winnipeg-based credit counsellor at Credit Counselling Society, a non-profit organization that has helped Canadians manage debt for more than 27 years.