What is Debt Consolidation?
Margaret Montgomery, Content Specialist
If you’re struggling with credit card debt, you’re not alone. Because of higher living costs, like pricier groceries and rising rents, many Canadians are saving less and relying on credit cards as a “de facto emergency savings account,” says a report from Licensed Insolvency Agency Hoyes Michalos. The report says that the average Canadian's credit card debt went up 11.4% in the first half of 2023, rising well above pre-pandemic amounts. Total credit card balances were a massive $113.4 billion in the latter half of 2023, according to Equifax Canada, which is 16% higher than the previous year.
If you're struggling with consumer debt or other forms of debt, you're not alone – but there are several options to help you work on it.
Debt consolidation is essentially the process of combining multiple debts into one. The goal is often to reduce monthly payments and the total interest accumulated on your outstanding debt. As a result, it should become easier to pay off your debt and thus also improve your credit score. Consolidating your debt can include combining debt from credit cards, car loans, lines of credit, and mortgages.
There are a few different routes you can take with debt consolidation, and the best one depends on your needs and financial situation.
“The main criteria that you'll want to investigate should you consider a loan or pay down current loan is making sure that the interest rate on that new product is lower than the interest rate on your credit card or other outstanding debts,” says John Lock, director of marketing at Credit Counselling Canada. He also says to consider the payment terms of any new debt agreement before signing onto it. If you increase the length of time you have to pay back your debts and your payments decrease, you'll be paying more in interest over time. Other things to consider are increasing your income or decreasing your expenses, especially discretionary ones.
But back to debt consolidation, there are five specific options we’ll explore:
1. Credit card balance transfer
Let’s assume you have two credit cards with balances on both of them. One charges 17.99% interest and the other charges 19.99% interest. We’ll say you have a $1,000 balance on the first card and $5,000 on the second. If you were to try to pay this debt off in one year, you’d need to make monthly payments of $551.01 and pay $612.12 in interest. It’s easy to see that as your debt accumulates, the interest on these cards can add up quickly. However, if you consolidate this debt to a balance transfer credit card, you may be able to pay off this debt more quickly and at a lower cost.
A balance transfer credit card offers an extremely low introductory rate, which will provide you with the opportunity to pay off your debt with one monthly payment and a lower rate of interest.
The MBNA True Line Mastercard offers 0% annual interest on balance transfers for 12 months. This card is a great option if you think you can pay off your debt within the one year period.
One thing to keep in mind with any balance transfer card is to avoid making purchases until your balance is paid off in full. Otherwise, you’ll end up paying the regular interest rate on future purchases and end up accumulating debt again.
2. Debt consolidation loan
You can get a debt consolidation loan from a major bank when you meet their qualification criteria, which may include factors like your credit score. The types of loans available are usually personal loans or lines of credit.
Personal loans are structured as regular weekly, bi-weekly or monthly payments on a predetermined schedule. The interest rate on a personal loan is usually lower than other options. Plus, you can receive a lump sum of money to pay off your debts upfront.
With a line of credit, you can borrow up to a set amount of money and you pay interest on the amount you use, not on a full loan amount like with a personal loan. Lines of credit offer more flexibility because you can use it whenever you need and for whatever you require the funds for. The interest rate on a line of credit is slightly higher than with a personal loan from a bank, however, and you have to stay on top of your payments or interest charges can spiral.
3. Debt management plan
A licensed credit counsellor can discuss all of your options with you based on your situation - not just loans, says Lock. They can help you determine if there is an opportunity to increase your income or decrease your expenses, and if not, they can help guide you to another option. One of those options is a debt management plan.
A debt management plan consolidates all of your unsecured debts, including credit cards, personal lines of credit, certain bills and more into one payment that you make to the credit counselling agency whom the counsellor works for. One thing to consider is that secured debts like student loans aren’t included in this option and will have to be paid off separately. You may also have to pay a small one time setup fee and a monthly fee. In some cases, paying off a debt management plan can take up to five years. A note will appear on your credit report that can have a negative impact on your credit score. The plan will also limit your ability to take on any new debts since the ultimate goal is that you pay off your debts entirely. Not all of your creditors may agree to this plan either, when the credit counselling agency approaches them.
4. Consumer proposal
You can also work with a licensed insolvency trustee - a debt management professional who works for the government. They can discuss options including a consumer proposal, a loan or bankruptcy, which we’ll explain below. A consumer proposal is a way for a licensed insolvency trustee to negotiate your debts on your behalf with lenders (those you owe money to), in order to decrease your interest rates, extend repayment deadlines, or both. The plan includes unsecured debts like credit cards and some forms of secured debts, unlike a debt management plan. Consumer proposals still affect your credit score, but it is a binding arrangement with creditors - meaning that there is more formality; once they agree to it, they have to stick to the rules. Licensed insolvency trustees are the only debt professionals who are licensed to give consumer proposals. There may be upfront fees associated with this option.
5. Declaring bankruptcy
If other options aren’t enough to help you get out of debt, a credit counsellor or licensed insolvency trustee may recommend bankruptcy. This is a legal process which involves releasing you from your debts. Part of the process may involve selling or surrendering your assets. It’s always best to speak to a licensed debt professional about your options when it comes to bankruptcy.
The bottom line
If you’re feeling overwhelmed with credit card debt or other forms of debt, it’s important to look into your options. Just be careful when signing onto loans and further forms of debt - make sure to find an accredited debt professional, like from a counselling agency, says Lock. “There are people who promise to eradicate your debt [right away] and they simply can’t. They will just take your money before resolving your situation and put you further into debt,” he says. Also - be careful with payday loans, which are short-term loans with high fees and interest rates. It’s important to explore all of your debt repayment options with a licensed professional before signing anything.