Canada’s “borrowing binge” is taking its toll. A recent study revealed that financial stress is a bigger worry than overall health for 30 per cent of Canadians, and the average Canadian spends about 7 hours a week worrying about their finances. To escape their debt and relieve their stress, many Canadians might turn to a debt consolidation loan.
A debt consolidation loan is when two or more debts are combined into a single loan that a lender provides you with so you can pay off the debts; then all you have to worry about is paying back the debt consolidation loan, and hopefully at a much lower interest rate. You're probably thinking, what's the catch? Well, the catch is in order to qualify for a debt consolidation loan you typically need a pretty good credit score, and let's face it, most people experiencing debt issues probably don't have the greatest credit scores. But if you've done your homework and you think a debt consolidation loan might be your best option, here are your next steps.
Obtaining a Debt Consolidation Loan
1. Gather Up Your Debts
You need to know where you stand financially and potential lenders will need to know how much debt you are carrying. So, pull together a complete list of all your debts, both secured and unsecured, including balances, monthly payments, and interest rates. You may not be planning to consolidate the secured debts (these are debts with collateral attached, such as an auto or home loan), but you still need to account for the balances and the payments. Lenders will need to know how much money you'll have available every month to pay back the consolidation loan.
2. Create a Spending Plan
Make sure you have a realistic spending plan, including all your monthly expenses (and we really do mean all of them) so you know what you can afford to take on in terms of monthly payments. A debt consolidation loan won’t help you if you can’t maintain the monthly payments, which could leave you worse off financially. Be sure to have a recent tax return or pay stub on hand to confirm your income.
3. Check Your Credit Report
If you aren’t sure how good your credit rating is, you can get a copy of your credit report for free once a year from both TransUnion and Equifax. Checking your credit report before applying for a debt consolidation loan could prevent any unexpected surprises throughout the loan application process.
4. Watch Interest Rates
Be aware of the interest rates. Banks and credit unions can usually offer you lower rates than a finance company, so make sure the interest rate on any debt consolidation loan offer is lower than what you are currently paying on the individual debts. Although one monthly payment to pay off all your debts might sound appealing, it’s not going to help you if the interest rate is higher than what you are currently paying on your various individual accounts.
5. Shop Around
Prior to making a loan application, you should shop around to see the interest rates currently being offered by various lenders. But be sure to do this within a 2-week period so it doesn’t affect your credit score.
6. Try Your Personal Bank or Credit Union
A good place to start when applying for a debt consolidation loan is the bank or credit union you currently deal with, as you likely have already established a (hopefully good) relationship with them. They will have a profile of your accounts, investments, and previous loans, which can speed things up a bit.
7. Let Your Lender Take Over
The lender will complete the application process, which will include your income, expenses, debts, and assets. They will also pull your credit report and credit score; after all, they want to determine if you are a reasonable risk and that you will be able to repay the loan. Lenders set their own guidelines as to the minimum credit score you need for them to approve a loan.
8. Negotiate and Read the Fine Print
If you’re offered a debt consolidation loan, don’t be afraid to try to negotiate a better interest rate than what they originally offer you (and again, make sure it’s lower than the interest rate on your individual debts). If you've done your homework, you'll have an idea of the rates other lenders are offering. The better your credit score is, the better your chances are of getting a lower interest rate.
Once you have agreed to the consolidation loan, make sure you understand everything in the loan agreement BEFORE signing it. Remember that you are signing a legal, binding agreement.
In most cases, the lender will contact your creditors to obtain the payout balances and then they will forward the funds to the creditors being paid off with the loan. If the lender is giving you the funds to make the final payments, make sure you contact the creditors to obtain the exact payout balance—you can’t go by the balances on your most recent statements.
9. Follow Up on Payments
Once the payments have been sent to your creditors, monitor your various statements to make sure the payments have been credited on your accounts and the balances are showing up as zero. If there is a remaining balance (maybe you didn't get the most up-to-date payout figures), make sure you clear the final balance so that the account is considered completely paid off, and again, monitor the statements to make sure the balance is zero. You should get another copy of your credit report in a couple of months to see if the accounts are showing zero balances.
Credit Cards and Debt Consolidation Loans
Depending on your lender, they may request that you close the credit accounts that the debt consolidation loan is being used to pay off, and/or destroy your credit cards. However, many lenders don’t require you to do this, which could make things worse for you.
I’ve spoken with many people who continued to use their credit cards in addition to having the new (large) debt consolidation loan to pay back, and it is not easy. Many end up in a worse financial position than when they started. It's one pitfall of a debt consolidation loan you definitely want to avoid! Continuing to use your credit cards and adding more debt defeats the purpose of a debt consolidation loan. Remember, you need to make the full monthly loan payment on time every single month, so make sure you have a realistic spending plan (including occasional expenses) to avoid the need for a future debt consolidation loan. You can find a wealth of free money management resources on Credit Canada's tips and tools page, which can help you build a spending plan and keep your expenses in check.
More Questions About Debt Consolidation?
Our counsellors are happy to answer any questions you have about debt consolidation and your particular financial situation. If you’ve gone through the debt consolidation loan process but were turned down, don't fret. Our Debt Consolidation Program could be the answer you're looking for. You don't need a good credit score to qualify for the program, and we'll consolidate all of your unsecured debt into one monthly payment, knocking the interest rate down to zero in most cases. The best part is that it doesn't require taking on an additional loan—it strictly focuses on paying off your debts with whatever funds you have available. Give us a call at 1.800.267.2272 and we can set you up with free counselling session with one of our certified, non-profit credit counsellors. The appointment is 100% free, confidential, and there’s no obligation.