It’s become all too easy to get trapped in debt nowadays. Although it might have made perfect sense to acquire the debt when you did, payments, especially when they come all at once, can become an overwhelming burden. If you’ve found yourself in such a situation, debt consolidation offers a way for you to easily and quickly get out of debt. However, is it the right path for you? Let’s see.
What’s the Difference Between a Debt Consolidation Loan vs Program?
First, it’s important to note that there is a difference between a debt consolidation loan and a Debt Consolidation Program (DCP), also known as a debt repayment plan—I know, I know, so many names. But I’ll try to make this as simple as possible.
What is Debt Consolidation?
When consolidating debt, you’re essentially bringing multiple sources of debt into a single, easier-to-manage account, usually in the form of either a loan or a repayment program. (More on that in a minute.) In effect, you are left with a single monthly payment instead of making multiple payments across the month to multiple creditors, which for some people can be half the battle when it comes to managing their debt.
What Is a Debt Consolidation Loan?
A debt consolidation loan is when you acquire funds through a single lender to pay off all of your outstanding debt and respective creditors. So then all you have to worry about is paying back that one loan (and lender) at a set interest rate and repayment schedule.
Not everyone is automatically approved for a debt consolidation loan. To be eligible for a consolidation loan you will need to have a good credit score and possibly collateral, like a car or a home. Conventional lenders base debt consolidation loans on credit checks through credit reporting firms, such as Equifax and TransUnion. Lenders will evaluate your credit history to determine their risk and your interest rate—the lower the risk, the better the rate. If you turn to an unconventional lender because you have a poor credit score or you don’t own any assets, you will pay a much higher interest rate, which can easily make your current financial situation worse.
What are the costs of a Debt Consolidation Loan?
The big cost of a debt consolidation loan is the interest, which typically increases the longer the repayment term is. (And the longer your repayment term is, the more it will cost you in interest charges.) It’s important to make sure the rate on the loan is lower than the current interest rate on your debt, otherwise, you’ll likely run into debt problems again.
If you do get a consolidation loan there is also a processing fee. There may be other costs as well, so be sure to ask for a full breakdown of all the costs involved before you decide to take out a debt consolidation loan with a lending institution, such as your bank. Before you agree to or sign anything it is crucial that you evaluate the amount you can comfortably pay each month, and then choose the terms accordingly.
Another thing to watch out for is upfront fees. If a company offers to process your debt consolidation loan but asks for an upfront fee, be wary, it could be a fraudulent company. According to the Loan Brokers Act, a lender cannot ask for an upfront fee. Otherwise, it could be an indication of fraud.
What are the risks of a Debt Consolidation Loan?
Getting a consolidation loan doesn’t necessarily mean your debt woes are over; it could just transfer them or potentially make things worse if you start to default on your payments. Failing to make the required payments on a consolidation loan will result in damaged credit and penalties, and if you took out a home equity loan to consolidate your debt, you might end up losing your home too! That’s why in some cases a Debt Consolidation Program (DCP) through a not-for-profit credit counselling agency might be a better option. You wouldn’t be taking on more debt, the interest on your current debt would decrease significantly (if not completely), and you can work out a repayment schedule that fits your budget while still taking care of your everyday expenses.
What is a Debt Consolidation Program?
As I mentioned earlier, a Debt Consolidation Program (DCP) is sometimes referred to as a Debt Management Program (DMP) or debt repayment plan, and it works a little differently from a debt consolidation loan. Rather than incurring more debt via a debt consolidation loan to repay your creditors, you work out a repayment plan you can safely afford to pay back your creditors, usually through a not-for-profit credit counselling agency.
A certified Credit Counsellor will negotiate with your creditors on your behalf to either stop or significantly reduce the interest on your debt, which lets you pay back your debt faster rather than just the interest. All you have to do is provide the non-profit credit counselling agency with a single monthly payment and they handle sending it to all of your creditors—no fuss, no muss. The bonus is you’ll no longer have to deal with your creditors or collection calls because your certified Credit Counsellor becomes your representative. They’re basically your go-between and they’ll handle any creditor-related issues for you.
What are the costs of a Debt Consolidation Program?
When it comes to a DCP, there is typically an initial set-up fee, which shouldn’t be more than $50. Also, a minimal portion of your monthly payment goes towards processing and managing the account.
What are the Benefits of a Debt Consolidation Program?
Easier Monthly Payment
When you consolidate your debt through a Debt Consolidation Program (DCP), you are left with one monthly payment instead of several payments. If you’ve had a situation where multiple payments are due almost at the same time, then you understand the pressure involved. A single payment can be a big relief. In the back end, this single monthly payment is broken down into individual payments for all your creditors.
Lower Interest Rates
A DCP or debt repayment program will significantly reduce or stop the interest entirely on your outstanding debt without having to take on additional debt, as is the case with a debt consolidation loan.
Quicker Repayment of Debt
If you have a regular source of income but you simply took on more debt than you can manage, a Debt Consolidation Program (DCP) is a leeway for you to get out of debt quicker and save on interest charges. By consolidating your debt through a DCP into a single monthly payment, along with a payment schedule that works for you and your current budget, you can effectively manage your debt in a way that works for both you and your creditors.
You can Adjust Your Debt Payment Period
The biggest advantage of consolidating your debt through a repayment program like a DCP is that it opens up the opportunity to negotiate with your creditors, including the repayment terms and payment period, so that it suits your capabilities and current budget. It can also give you more time to get your finances in order, so you can make regular payments comfortably.
What Are The Downsides Of Consolidating Your Debt?
Consolidating your debt will require that you close off all your credit card accounts to further charging. This means you cannot use your credit cards even if an emergency arises. While this may seem like an inconvenience, it’s also an opportunity for invaluable insight into financially-conscious living. For example, you can look into getting a prepaid or reloadable card that works more like a debit card. You make a deposit on the card and whenever you use it that amount automatically gets deducted from the card balance. Once you’ve spent your entire deposit amount you simply reload the card. If you get into the habit of regularly contributing a small amount of your disposable income to an emergency fund via a prepaid or reloadable card, you will be steps ahead in your personal financing.
Is Debt Consolidation Worth The Risk?
Debt consolidation offers a leeway to finally get on top of your debts, but it’s important that you fully understand why you are in debt and if debt consolidation offers you a favourable solution. Remember, most people fall into debt at some point in their lives. What’s important is to manage it effectively and use professional advice when you need it, especially if it’s free.
Credit Canada Can Help You Get Out of Debt
As the longest-standing not-for-profit credit counselling agency in Canada, Credit Canada has been helping Canadian families achieve financial freedom for over five decades. We are recognized as industry leaders for our extensive experience, in-depth financial literacy, and commitment to helping Canadians from all walks of life. Contact us today to arrange a free debt and credit counselling session with one of our certified Credit Counsellors, and they’ll be able to determine what’s possible for you.
