What is debt consolidation?
Debt consolidation in Canada is the process of procuring a new loan to pay off all your previous loans and debts.
When you owe money to multiple lenders, it becomes difficult to be on top of all the monthly payments of these loans.
By consolidating your debts, you have to worry only about one single monthly payment.
A point to be noted here is that by consolidating your debt, you do not erase your original debts.
You just transfer all those debts into the new one.
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Consumers can apply for such consolidation loans through a bank, a credit union or even a credit card company.
It is an added advantage if you have a good rapport with any of these institutions as you can negotiate a favorable deal with them.
On the other side, if you are not entertained by them, then try to get a loan from private lenders.
Why should you consolidate your debts?
There are three main reasons why you should consolidate your debts.
They are –
1) Ease of tracking the debts
When you have a single monthly loan payment, it is much easier to organize the budget for that month.
Also, you do not have to keep track of multiple due dates for your loans.
2) Better payoff terms
When you consolidate your loan, you have a chance to negotiate good payoff terms with the creditor.
For example, you can negotiate a lower interest rate or lower monthly payment or even longer duration to pay off the loans.
3) Lesser stress
Even though a consolidated loan will have a higher loan amount, the better payoff terms for a single loan will give you peace of mind as opposed to managing multiple smaller loans with poor payoff terms.
Types of Debt Consolidation
Broadly there are two types of debt consolidation loans – secured and unsecured loans.
Secured loans are often backed by the borrower’s property or even by a prepaid amount.
This works as the collateral for this loan.
Secured loans have lower interest rates.
The other loan type is the unsecured loan which is not backed by any asset.
These loans have a higher interest rate.
Both types of loans have a lower interest rate as compared to credit cards and also the interest rates are fixed, thus aiding in the debt consolidation process.
But if you have collateral, then it is always ideal to go for a secured loan which will give a better interest rate thereby justifying your debt consolidation exercises even further.
Steps in Debt Consolidation
To qualify for the debt consolidation loan, you need to have sufficient income and adequate creditworthiness as you are going to a completely new lender.
The documents needed might vary based on the country you are located or even your credit history.
For example, in Canada, you are asked for your monthly budget that shows your capability to manage the loan repayment, a piece of evidence to prove that you can make the payment such as your pay stub and collateral or a co-signer to give that additional level of security.
Once you have successfully procured your debt consolidation loan, the next step is to decide who you should pay off first.
Most of the time, the lenders decide this and will choose the order of repayment.
If you have the option to choose, then pay off those charging high interest first.
But if you think there is a loan that is causing you bigger stress such as a personal loan taken for a sad cause, you can always start with that.
Risks in debt consolidation
The biggest risk in debt consolidation in Canada is a person’s mindset to consider it as an easy solution to repay off their past debts and to save some amount for emergencies and unexpected expenses.
Unfortunately, a debt consolidation loan is also a liability and will not leave you with a sufficient amount for emergencies and unexpected expenses, just like your past debts.
In case of an emergency, you will end up taking another loan to cover it, and the cycle continues.
Also if you have placed collateral for the consolidated debt, you might end up losing it if you are unable to pay back the consolidated loan on time.
This is another risk you should consider before opting for a debt consolidation loan.
Debt consolidation has helped many borrowers in the past to streamline their loans and to improve their chances of repaying them.
Advantages such as better payoff terms, easy to tack the debts and peace of mind will be tempting for you to opt for a debt consolidation loan.
But there are certain risks involved in it too that can put you in a worse spot if adequate planning doesn’t go into your debt consolidation planning.
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