Will a Debt Consolidation Loan Help You Get Out of Debt?

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You’ve likely seen the ads for debt consolidation loans, or home equity loans on TV or on Social Media, offering easy money to people who have been rejected by the banks. For those of us struggling with debt, any option that promises relief from financial pressures can seem appealing.

There are plenty of people for whom debt consolidation loans have worked, but they’re not for everyone. They can help you lower the cost of repaying debt. However, there are plenty of pitfalls to avoid, and not all loans are made the same.

How Does a Debt Consolidation Loan Work?

A debt consolidation loan is a way to refinance your existing debts at a lower interest rate. You take out a new loan at a lower interest rate and use the money to pay off any existing debt. If you’ve been missing payments or you’re getting calls from collectors, it’s a way to buy yourself some time. It can also let you turn multiple bills into a single monthly payment, which can help when you can no longer keep track of all your payments. Most importantly, your new debt consolidation loan should come with a lower interest rate than what you’re currently paying.

Interest rates stretch your budget thin and reduce your purchasing power. The average APR (Annual Percentage Rate) on credit cards is around 16% or higher. If you’re carrying a $5,000 balance on a card, It will take you 13 years and 9 months (165 payments) to be rid of your debt, if you are only making minimum payments. In that time, you will pay:$3,687.56 in interest. Interest is money that goes straight to your creditor without paying down your principal (The original amount owing).

How does a debt consolidation loan work to get you out of the red? In the best-case scenario, you can use a debt consolidation loan to pay off those high-interest debts and replace them with a single debt at a lower interest rate. You will have more money to pay off the principal, allowing you to get out of debt sooner without having to increase your income. It will save you money in the end.

With the right loan, the benefits are clear:

  • You turn multiple loan payments into a single payment that you’re less likely to forget
  • Lower interest fees free up more money to pay down principal
  • You can get out of debt faster

However, not all loans are the same, and given how debt consolidation works, higher-interest options might just delay the problem or make it worse.

What Types of Debt Can You Consolidate?

Not all types of debt can be consolidated. Secured debts such as car loans are subject to your initial agreement, and you may not be able to pay them off early unless the lender agrees. The lender may charge you a pre-payment penalty or pre-computed interest. Pre-computed interest is a fixed amount of interest you will have to pay even if you decide to pay off the loan early.

Low-interest loans like student debt also rarely make sense to consolidate. The primary benefit of consolidation is saving money on interest rates. If you’re struggling to find a low-interest consolidation loan, you may want to learn about the advantages of a consumer proposals instead.

The types of debt that make sense for consolidation include:

  • Credit cards
  • Payday loans
  • Overdue bills
  • Taxes owed

The debt consolidation process can save you money on interest rates and fees. Just make sure your new loan has a lower interest rate than the rates you’re currently paying.

How to apply for a Debt Consolidation Loan?

You have several debt consolidation options to consider. Each option has its own risks and challenges. Often, the best options are the hardest to qualify for by the people who need them.

Unsecured line of credit or debt consolidation loan:

The lowest interest rate without putting up collateral is likely through an unsecured line of credit offered by a bank or credit union. This will likely require you to have a good credit score to qualify.

Home equity line of credit or mortgage refinancing:

This option allows you to use the equity built up in your home. If your mortgage is up for renewal, it may be a good time to refinance. With a home equity line of credit, you may only be required to pay the interest on your loan. However, this means you would not be making any principal payment on your original mortgage.

Balance transfer card:

You may be able to use another credit card to pay off existing debts. If you can qualify for a low-interest credit card, it may make sense to transfer balances with higher interest rates.

Determining the Interest Rate You Have to Pay

The interest rate and term are the most important factors in determining whether or not a debt consolidation loan is a good idea. The better your credit score, the lower the interest rates the lender will be willing to offer. A low credit score means you may not be able to qualify with a bank or credit union, and you may have to rely on a lender that charges much higher rates to cover the risk.

The available interest on debt consolidation loans ranges widely depending on your credit score. If the interest rates are higher than what you already pay, debt consolidation is not a good financial plan.

In addition to your credit score, there are other factors that will determine your total costs.

Secured Loans

One of the most effective ways to reduce the APR is to take out a secured loan, i.e., one with collateral. You may be able to borrow against your car, home equity, or another asset. Taking out a Home Equity Line of Credit (HELOC) or a second mortgage may work, but keep in mind that you’re also putting your home or other valuable assets on the line.

Fixed vs. Variable Rates

Fixed-rate loans charge the same interest for the length of the term. You know exactly how much you have to pay in the end, no matter how market rates change over that time. Fixed rates tend to be somewhat higher because the borrower takes on the risk that market rates will rise over time.

Variable rates change periodically, and that could change the minimum payments you have to make, based on how market rates have changed over time. Right now, interest rates are historically low, so a significant rise could make a variable rate loan unaffordable or change the equation compared to your original debts.

Fixed-rate loans may prove more expensive, but they provide stability and predictability. Changing rates could upset your plans.

Fees

On top of the APR, lenders may charge balance transfer, processing, or application fees. There might also be costs to appraising your mortgage if you are getting a secured loan.

How to Get Approved for a Debt Consolidation Loan?

The problem with how to qualify for a consolidation loan is that you generally need good credit to get approved by a bank or a credit union. As with any loan, these financial institutions typically offer the lowest interest rates but won’t lend money to high-risk borrowers.

Many of the people who find themselves looking for a debt consolidation loan already have a high credit utilization rate, a history of missed or late payments, or may already have accounts in collections. These are all factors that reduce your credit score and could be the reasons that your loan application gets denied.

While you can qualify for higher-interest loans with an average or fair credit score, a poor credit score may mean you can’t qualify at all. In this case, you would be better off exploring options like a consumer proposal or bankruptcy.

Your credit score is not the only criteria applicants are judged on. The lender will also take into account:

  • Your income and its stability
  • Assets and investments
  • Debt-to-income ratio
  • Employment history

Debt Consolidation Loans VS. Consumer Proposals

debt consolidation loan is only one of the many options available when seeking debt relief. In some cases, a debt consolidation loan is not the best option for controlling your debt. David Sklar & Associates does not provide debt consolidation loans. If you’re looking for a loan, we suggest you speak to your bank first to see if you qualify for one. Many people find that a consumer proposal is a better option for debt relief than a debt consolidation loan.  

consumer proposal will significantly reduce the amount of debt you actually owe, stop interest charges, stop collection calls, prevent any legal action against you, consolidate all of your debt into one low monthly payment and allow you to become free in 5 years or less!

Debt Consolidation Loans VS. Bankruptcy

Bankruptcy may not be your only debt relief option, but it is an effective last resort when necessary.

Issues to Avoid in the Debt Consolidation Process

Debt Settlement Programs:

If you’ve been rejected for a debt consolidation loan, be wary of debt settlement programs that promise consolidation solutions, as many of these are predatory by nature and may not be in your best interest. According to the Collection and Debt Settlement Services Act, if you sign up for one of these debt settlement programs, you have a 10-day cooling-off period in which you can change your mind and nullify your contract without reason.

Limited-Term Low Interest:

Sometimes, low-interest rates are only offered for a limited time, especially with balance transfer cards. If you don’t believe you can pay off the balance before that term expires, make sure you’re still getting a good deal on later interest rates.

Long-Term Loans:

Finally, long-term loans can make your debt more expensive by stretching out payments and maximizing the interest that collects. It may make monthly payments more affordable, but it’s costlier in the long run.

Debt consolidation can work, but you have to be careful that you’re signing up for the right solution. Look for a loan that will reduce your monthly payments and interest charges and that will help you get out of debt sooner.

Take Your First Step Towards A Debt Free Life

If you are overwhelmed by debt and live in the Toronto area, call us at 416-498-9200 to book a FREE, confidential appointment. We will review your financial situation in detail and discuss all of your options with you. Alternatively, you can fill out the form below and our team will reach out to you. 

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I filed a proposal with another group, which came in as a referral from one of my brokers. My experience went from ok to bad to worse, due to lack of communication and education on the process I was to embark on. I worked with Cori Naron in the past, and I came to her now for help on literally doing the work that the other group should have done. Cori stepped in, educated me, advised on rights, responsibilities, how the process works and what potential outcomes may happen. I do not have enough words of recognition and gratitude for what she did - she alleviated stress, anxiety, dead-end thoughts and she made me live again. Congrats to DSklar for hiring her and retaining such talent.
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I have had the privilege of being supported by Jackie S, at David Sklar n Associate.She was helpful, professional and friendly. I was able to get the help I needed at a difficult time in my life. I would recommend anyone who needs support with working out their debts to ask for Jackie, she will be waiting to assist however she can to help you through your debts. She works with a team who is always ready and responsive.Thank you Jackie and your team:)
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