What is debt consolidation?

Qu'est-ce que la consolidation de dettes

What is debt consolidation?

Debt consolidation is a form of debt management solution that consists of applying for a loan to pay off all your current debts and pay a single lower-interest loan over a certain period of time.

This solution is great for people with multiple high interest debts such as credit card debt. If you have been falling behind on your loan payments, you can consolidate your debts to make them easier to manage and pay back.

Ultimate guide to debt relief in Canada

How to consolidate your debt?

If you think that debt consolidation might be the right solution for you but you don’t know where to start, here is a quick rundown of how debt consolidation works. However, please note that you should always consult a professional to analyze your financial situation and seek expert debt advice.

As previously stated, debt consolidation is the process of combining all your debts to allow you to pay them off more easily. In order to do this, you have to apply for a consolidated loan. You then have to respect your payment obligations until your debt is cleared.

Once you have identified that debt consolidation is the right course of action for you, you will need to identify where you are going to obtain your consolidation loan and from whom. Whilst most people obtain their debt consolidation loan from their bank, if your bank denies your request, there are alternative options you can seek out, such as mortgage companies or other lenders

On the whole, creditors are eager for debt consolidation loans to be approved as it shows that the indebted individual has the intention to pay back his/her debts and improve his/her financial situation. Debt consolidation loans help to ensure you pay off your debt and your creditors get the money they are owed. 

Debt settlement vs. debt consolidation

When talking about debt consolidation, it often gets confused with debt settlement. When you get a consolidation loan, your original debt does not disappear, it is simply redirected as all your debts get transferred to a new lender.

On the other hand, debt settlement seeks to minimize the amount that you actually have to pay back instead of the number of creditors you have to pay back. Some creditors will negotiate an agreement with you so that you can pay back less than you owe to make it more manageable for you and allow you to clear your debts faster than you might otherwise have been able to. 

Debt settlement and debt consolidation are both forms of debt relief that seek to make your financial situation easier to manage. However, you should keep in mind the creditors are in no way obligated to let you off any of your debts so not all of them will agree to settle and go down the debt consolidation route. This is why it’s important to contact a financial expert to explore different debt management solutions that are adapted to your individual situation and needs.  

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What are the requirements to be eligible for debt consolidation in Canada? 

Applying for debt consolidation is not always easy as there are a few things that creditors are looking for. If you do not meet any of the requirements for debt consolidation, there is a high chance that you will be found ineligible. If you’re a Canadian looking to apply for debt consolidation, these are the key things that your creditors are going to be looking out for:

1. Credit Score

Your credit score is a good indicator of the likelihood of you being eligible for a debt consolidation loan. If you have a poor credit score, your creditors will think you have a history of financial irresponsibility. This is a red flag for lenders as it suggests that it is risky to lend you money. 

Although it is not impossible to be accepted for a debt consolidation loan with a bad credit score, it does make it far harder. The best way to get around a poor credit score is to prove to lenders that you are not as risky as you appear on paper. The best way to do this is to have a strong co-signer on your application

How to pay off credit card debt 

2. Income 

Creditors and lenders will check to see if you have a constant and stable source of income before granting you a debt consolidation loan. Banks and lenders want to verify that you have the financial capabilities to pay your consolidation loan. 

If you have a steady and constant source of income, they will be more likely to trust you as it gives them confidence that you will be able to respect your payment obligations and avoid falling behind on payments. 

3. Spending

On a similar note to income, you also need to prove that you are not spending in excess of your means. The bank or your lenders will ask for a list of your regular expenses to see how much money is coming out compared to how much is going in. 

Therefore, if you spend money on things that you don’t need, which affects your income spending ratio, you might want to reconsider your spending habits. Even if you have a steady source of income, if creditors see that you are irresponsible when it comes to managing your money, they won’t agree to grant you a consolidation loan. Overall, if you are unable to prove your ability to pay your loan back, or you have a bad credit history, you will be found ineligible for a debt consolidation loan. 

Budget and money saving tips 

Benefits of debt consolidation

Low interest rates 

When you start to accumulate debts and loans, the banks and financial institutions that you borrow from will likely charge you higher interest rates, especially when it comes to unsecured loans like credit card loans. This means that you will have to pay back more than you originally owed. 

One of the main advantages of debt consolidation loans is that they offer you a lower interest rate which makes it easier to pay back your debt. If you have a good credit score, you will be rewarded with a lower interest rate, whereas poor credit scores will lead to higher interest rates. However, debt consolidation loans generally have lower interest rates than other types of loans. 

Shorter payback period 

Most other types of loans do not really care how long it takes you to pay back the money you owe because they will earn money on it through interest. However, the faster you can pay off a loan the better. Debt consolidation loans take multiple things into consideration when determining your interest rate and the length of your loan (your income, how much you owe, etc.). Generally speaking, consolidation loans have a shorter repayment period. 

Reduces stress

Having all your loans and debts in one place, with only one creditor to pay off will make your life much easier. Plus, since your payback period is generally shorter, you will be able to pay back your debt faster. This will reduce your financial stress.

Downfalls of debt consolidation  

Hidden costs 

Hidden costs are a problem when it comes to debt consolidation loans. There are often opening and closing fees, as well as annual fees, amongst others. Therefore, when looking for lenders, be sure to compare all of their hidden fees and costs.

Encourages overspending

Often when people are accepted for debt consolidation loans, it causes them to be lulled into a false sense of security. When this happens people often spend beyond their means, which only puts them into more financial trouble. Therefore, if you are considering debt consolidation, you should make sure to control your spending habits and budget.

Can increase your interest rates

Although the aim is to decrease your interest rate, if you get your strategy wrong, it can in fact raise your interest rate. The most important thing to keep in mind is that you want the APR to move from a higher credit card APR percentage to a lower APR percentage. 

Example of debt consolidation

There are a few different types of loans that are frequently consolidated, below are a few:

  • Credit card loans 
  • Student loans 
  • Home Equity loans 

Is debt consolidation the right move for you? 

To know whether or not debt consolidation is the right choice for you, it’s important that you consult a licensed insolvency trustee to explore all the solutions available to you. Talking to an expert from Groupe Serpone can help you better understand your financial situation and what your options are. 

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