To get the scoop on consolidation loans I went straight to the source (undercover posing as a university student researching for a finance paper). I set up a meeting with an account manager at one of Canada’s major banking institutions. The manager greeted me with a firm hand-shake and invited me to sit down with him in his sliding glass door office.
He explained to me that a consolidation loan is when the bank will group a number of debts together so the client only pays one loan back usually over a 5 year time frame at an interest rate ranging from 6-15%. The bank does not fork over money directly to the client but rather the money is used to pay off the debts in full.
Those old debts are then closed and no longer active. This type of loan may be of interest to people who have maxed out their line of credit and have high interest credit cards of which they are only making the minimum payment every month. The idea behind the consolidation loan is that the interest should be less than that of the original debts in order to pay down the principal faster partnered with lower payments. Sounds like a great deal, doesn't it? Well, I had to ask how the bank decides who is accepted and if so how they determine the interest rate based on the 6-15% range.
It seems there are a number of important factors such as the client’s credit history and something called the Debt-Service Ratio (DSR). The DSR is calculated based on the amount of money put towards paying your current debts compared to your income. If 35% or higher of your monthly income goes towards paying off debts then there is little chance you will be accepted for a consolidation loan. And as for the interest rate offered, just like any other loan, higher risk clients get a higher interest rate to compensate for the risk the bank is taking by loaning the money. It was noted that only highly desirable clients will be eligible to consolidate debts outside of the bank offering the consolidation loan.
For example, it’s easy to consolidate all CIBC debts with CIBC but if you want CIBC to pay off your RBC debt you had better be an ideal client! But you have to ask yourself, would the ideal client even need a consolidation loan? Here’s the kicker. When I asked how common consolidation loans are, suddenly the account manager could not comment. He bowed his head and smiled sheepishly. I tried to probe further, “If someone is denied for this type of loan, what options do they have?”
Suddenly, the conversation livened again; the client can look for a guarantor to co-sign on the loan, i.e. a spouse or relative who is also held responsible for payments should the client not keep up with the payment arrangements. Again, a co-signer’s credit history and debt-service ratio are taken into consideration. If this fails, the client needs to find other ways to deal with their high interest payments and maxed out cards. I’ve heard of consolidation loans being referred to as unicorns. Wonderful creatures that sadly do not exist in reality.
The statistics surrounding acceptance rates are not easy to come by. The banks are certainly not eager to share such information but it sounds to me as though consolidation loans are few and far between. If you’ve been denied for a consolidation loan with a bank in the past and feel you are chasing after a unicorn, there are other options. Credit Canada, offers another kind of debt consolidation. While not a loan, the Debt Consolidation Program is a way to pay off debts by stopping or lowering the interest rates and making one monthly payment. The payment is distributed to all accounts on the program and the balances are slowly paid down over time. Even if a client has poor credit history, this type of repayment program is still an option. What a credit counsellor looks at is the client’s monthly income, monthly expenses and their debts.
As long as there is a surplus in the budget large enough to pay off the debts (with interest relief) within 4 or 5 years then this is a viable option to consider. If you’d like to discuss your specific debt situation and hear your options you can book an appointment by calling 1-800-267-2272. So leave those unicorns to fairy tales!