Area of Law: Credit, Debt and Bankruptcy
Answer Number: 0273
What is debt consolidation?Region: Ontario Answer Number: 0273
Although personal bankruptcy allows you to make a fresh start free of most of your debts, if you have a steady income and a satisfactory credit rating, you may want to consider other options with less serious consequences. One of these is debt consolidation.
Debt Consolidation Loan – from your financial institution
Debt consolidation refers to consolidating all of your debts into one.
A debt consolidation loan is a single loan, available from banks, credit unions and another financial institutions, which you use to repay the debts you owe to several, or all of your creditors.
What debts can be consolidated?
The most common debts you can consolidate are:
- credit cards
- public utilities
- other consumer loans, including lines of credit
Advantages of a debt consolidation loan
A debt consolidation loan is a good idea for three reasons:
- once you pay off what you owe using the loan, you will then only have to make one payment each month instead of multiple payments to your credit card providers or other lenders;
- your interest rate will generally be lower than the interest rate on your credit cards or other consumer loans; and
- your debt will be paid off in a set amount of time (typically 2 – 5 years).
Disadvantages of a debt consolidation loan
There are also disadvantages to debt consolidation loans, including:
- you must qualify for the loan with your financial institution, generally by having a good credit rating and sufficient income to make the consolidation payments
- if your credit rating or income is not acceptable you may have to provide some kind of collateral (e.g. lien against a car or other property, a second mortgage on your home) in the event you cannot make your payments
- although the loan may have a reduced interest rate and it replaces multiple smaller payments each month, you must still be able to afford the one large monthly payment
- if you miss payments or make late payments, your credit score will decline
How will a debt consolidation loan affect my credit score?
Having a debt consolidation loan will typically affect your credit score in a positive way. Although taking a new loan is added to your credit history, it removes the older loans and they are reported as paid in full, which will have a positive effect on your credit score. As well, if you always make your new loan payments on time and consistently, this also positively affects your credit score, although it make take some time.
A credit counselling agency can help you with applying for a debt consolidation loan or provide advise and help with other solutions to manage your debt.
Informal arrangement with creditors
If you do not qualify for a debt consolidation loan, a credit counsellor may suggest you try to make an informal payment arrangement directly with your creditors yourself. They may agree to let you pay a lesser amount, or make your payments over a longer period. You should first learn how your credit rating will be affected before agreeing to such arrangements. Sometimes creditors agree to reduce your debt or extend the repayment term, but will still report you to the credit bureau.
There are many options to consider when you are in a situation of financial difficulty. Before deciding to file for bankruptcy, it is advisable to meet with a Licensed Insolvency Trustee or bankruptcy lawyer to review your situation and what other options you may have.
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