Debt consolidation is a financial strategy that combines multiple debts into one payment. For instance, if you have multiple high-interest credit cards and an unsecured personal loan, you can consolidate all of these debts into a single monthly payment. In other words, you use one big loan to pay off multiple smaller loans. Debt consolidation can simplify your debt repayment process. It can also help reduce your monthly debt payments if you can secure a loan with a lower interest rate.
This article outlines what it takes to qualify for debt consolidation, the different debt consolidation methods, and other debt relief solutions.
How to Qualify for Debt Consolidation
A consolidation loan can help you get out of debt faster if you can secure a loan with a lower interest rate than the debts you currently have. If you want to be successful in repaying your debt, you will want to avoid taking on new debts while you’re paying off your consolidation loan.
When looking to consolidate, different lenders will have different qualification criteria. Some of the key variables lenders will review when deciding if they want to lend to you include:
Credit score
The exact credit score you need for a consolidation loan will vary between lenders. Typically, a higher credit score can help you qualify for a loan with a lower interest rate. If you have a lower credit score, you might want to consider other debt solutions because you will likely struggle to qualify for an interest rate low enough to make debt consolidation worth it.
Income
Potential lenders might ask for proof of income to assess if you can afford to repay your loan payments. Lenders might request pay stubs, bank statements, or other documentation to confirm that you’ll be able to repay your debt.
Debt
Lenders will typically look at your debt-to-income ratio (DTI) as another qualification criteria. Your DTI is a measure of how much of your pre-tax income goes towards debt repayments and indicates your ability to pay back your debt.
Collateral
If you’re struggling to qualify for a debt consolidation loan, you might consider applying for a secured consolidation loan. With a secured loan, you have to provide collateral in the form of your car or house. Typically it’s easier to qualify for a secured loan because the collateral helps to reduce the risk to the lender. However, if you can’t repay your loan, you risk losing your collateral.
What Type of Debt Can You Consolidate?
Typically, you can use debt consolidation loans to consolidate unsecured debts, including:
- Credit cards
- Medical bill
- Personal loan debt
- Private student loan
- Personal line of credit
- Phone bill
- Medical bill
- Some payday loans
Debt Consolidation Options
There are several different debt consolidation programs available, including:
Personal debt consolidation loan
Banks, credit unions, and other financial institutions may offer personal debt consolidation loans. Before taking on a debt consolidation loan, consider the interest rate you qualify for.
Without a good or excellent credit score, you may find it difficult to qualify for a loan with a rate lower than you are currently paying.
You also want to make sure you qualify to borrow enough money to consolidate all of your debts.
Balance transfer credit card
Another consolidation option is to transfer your debt from other high-interest credit cards to the balance transfer credit card. Ideally, you want to find a balance transfer credit card that offers an interest-free introductory period. Typically, the intro period ranges from six to twelve months.
During the intro period, the goal is to pay off your debt before the interest-free period ends. If you can do this, you can save big on interest. If you can’t pay off your balance, you will have to pay the higher interest rate once the intro period is over.
Make sure you confirm what the regular interest rate is. Also, consider that most balance transfer cards come with a balance transfer fee that is typically 1% to 5% of the amount you are transferring. For instance, if you are transferring $5,000 and there is a 3% transfer fee, you will pay $150.
Home equity loan
If you’ve built equity in your home, you may be able to borrow against it using a home equity loan. Home equity is the amount of your home that you own. For instance, if your home is worth $400,000 and your mortgage balance is currently $300,000, then your home equity is $100,000.
The benefit of a home equity loan is it often comes with a lower interest rate compared to other lending options.1 However, a home equity loan is a secured form of borrowing so, if you don’t make your payments, you risk losing your home.
Other Debt Relief Solutions
If you decide that debt consolidation is not the right choice for you, there are other debt relief options available, including:
Credit counselling
The purpose of credit counselling is to help individuals struggling with debt improve their financial skills and knowledge. For instance, a financial counsellor might teach you how to create a budget to help you manage your monthly finances.
There are not-for-profit and for-profit credit counselling agencies in Canada. Make sure you do your research before choosing a credit counsellor to ensure they are trustworthy and qualified. If You can use the Credit Counselling Canada website to find a not-for-profit counsellor.
Debt settlement
You can hire a debt settlement company to negotiate with your creditors to reduce the amount of credit card debt you repay. If your creditors agree to reduce the amount you owe, you then have to produce a lump sum payment. While debt settlement may work in some cases, your creditors do not have to agree to negotiate. They can refuse to work with the debt settlement company.
Most debt settlement companies charge a fee for their service whether they are successful in reducing your debt payment amount or not. If your creditors refuse to work with the debt settlement company, it’s possible that you will still have to pay for their services. This leaves you in a worse position than when you started. You still have to repay all of your debt as well as the debt settlement companies fee.
Consumer proposal
If you are at a point where you can no longer afford to pay your bills, you might also consider a consumer proposal. A proposal is a legal process that can only be administered by a Licensed Insolvency Trustee (LIT). You and your LIT work together to create an offer to your creditors where you propose to pay a percentage of your debt.
Similar to debt settlement, you can reduce the total amount of debt you have to repay. However, in a consumer proposal, you don’t have to come up with a lump sum payment. Instead, you agree to make affordable monthly payments over a fixed period of time (to a max of five years).
The Bottom Line
If you’re carrying multiple high-interest debts and you want to simplify your debt repayment process, debt consolidation services might work for you. However, to really benefit from debt consolidation, you have to find an interest rate that is lower than what you are currently paying. If you have a poor credit score, you might find it challenging to secure a loan with a low enough interest rate to make consolidation worth it.
Sources:
- Equifax. Home equity loan vs. home equity lines of credit (HELOC). Accessed August 15, 2023.
- Credit Counselling Canada. Find a qualified counsellor. Accessed August 15, 2023.
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