Dealing with debt can be an intimidating prospect for anyone. Even if you have a great annual salary, it can be surprisingly easy to start amassing uncontrollable debt that seems impossible to deal with.
The average level of debt held by Canadians is on the rise—though different age groups are seeing different levels of debt and growth rates. For example, the average debt of an 18-25 year-old in Q1 2022 was about $8,129 (a 4.09% drop from Q1 2021—making this the only age group to see a decrease). However, every other age bracket saw increases in average debt year-over-year:
- 26-35 year-olds had an average debt of $16,832 (up 2.83%)
- 36-45 year-olds had an average debt of $25,084 (up 3.57%)
- 46-55 year-olds had an average debt of $31,442 (up 2.82%)
- 56-65 year-olds had an average debt of $26,165 (up 1.12%)
- 65+ year-olds had an average debt of $14,386 (up 0.35%)
Debt consolidation is one option for dealing with rising debt. We wanted to talk about debt consolidation—what it is, how it works, and whether debt consolidation is right for you (and if so, what kind of debt consolidation would be best).
What Is Debt Consolidation?
Debt consolidation is the practice of taking multiple sources of debt and combining them into a single account. This offers several advantages for borrowers. First, it makes it easier to keep track of payment due dates. Going from having to remember a half-dozen days of the month to make bill payments to only having to remember one can be a huge load off of your mind.
It also makes it easier to keep track of your creditors. With one bill to pay, you don’t have to worry as much about whether you lost track of one of your debts in any given month. The peace of mind this provides alone can be a good reason to seek out debt consolidation.
How Does Debt Consolidation Work?
Debt consolidation can work in different ways depending on who you work with. There are two major types of debt consolidation that you can pursue: debt consolidation loans and debt consolidation programs (DCPs).
It’s important to know the differences between DCPs and loans so you don’t fall for any of the myths about debt consolidation that occasionally get shared online.
Debt Consolidation Loans
What is a debt consolidation loan? It’s a service from a bank or other lending institution where they consolidate (i.e., “merge”) several debts into one by providing a loan to cover the cost of the existing debts.
To qualify for debt consolidation loan services, it’s important to have good credit. A high credit score can help you qualify for a loan with better terms such as having a lower monthly payment or having a lower overall interest rate. However, if you have a low credit score, lenders may not want to provide you with a consolidation loan.
Debt consolidation loans can be a great way to simplify repaying your debt while keeping any impact to your credit score minimal.
Debt Consolidation Programs
For those who might not have the credit history or credit score required to get an ideal consolidation loan from a bank or other lender, a debt consolidation program could be an excellent alternative. How does debt consolidation work differently in a DCP from a loan?
One of the biggest differences is that you aren’t applying for a loan—so you don’t need a good credit score. Instead, you work with an intermediary to negotiate with your creditors to have them reduce your debt, minimize or eliminate the interest on it, and combine it into a single, easy-to-track monthly payment.
Because this is a negotiation and not an immediate payoff, your debt doesn’t just “go away.” It still exists, just in a more manageable form. Additionally, not all creditors may wish to work with you on a DCP. They may insist on not being made part of the program. However, an experienced counsellor can often find terms that work for both you and your creditors to get them on the program.
Which Type of Debt Consolidation Is Right for You?
So, which type of debt consolidation is the best for your needs? That depends on your specific situation. It’s important to consider the differences between a DCP and a consolidation loan before choosing one or the other.
For example, did you know that signing up for a debt consolidation program means forgoing your credit cards? At first, this sounds like a negative since we’re all used to the convenience of credit. However, it is often a blessing in disguise for those who are struggling with massive debt.
Even under a DCP, you can still use prepaid cards or debit cards with credit logos (the ones that draw from your bank account but can be processed like they’re credit cards). By cutting up your credit cards and closing the accounts, you can eliminate the temptation to keep spending on your cards after you’ve paid them off—helping you avoid adding more debt just as you start paying it off!
If you have a high credit score and can secure a loan with great terms, then a debt consolidation loan might be your best choice. It not only helps you eliminate your other sources of debt immediately (transferring them all to the loan), but it allows you to keep building your positive credit history if you keep making your monthly payments on time.
However, if you have poor credit and can’t get a loan with favourable terms, then a DCP may be the better option.
Balancing the Benefits of Debt Elimination Strategies
It can help to run a check of your current outstanding debts and compare the cost of paying them off in a loan vs the cost of negotiating them down with reduced interest in a DCP. This is something that a debt calculator tool could help you with. Simply plug in the value of the debts, their interest rates, and how much the monthly payment would be, and get an estimate of how long you’d be paying it off using five different repayment strategies (and how much you would pay in interest over that time).
For example, if you had a debt of $20,000 with an annual interest rate of 20%. Here are some approximate payoff times and interest amounts:
- Minimum Payment Method (2.5% of Balance). This would take over 25 years and amass over $36,750 of interest over that time.
- Paying $500 a Month. This would clear the debt in about 5.6 years and add about $13,233 of interest over that time.
- Consolidation Loan at 8%APR (Paying $500/Month). This would clear the debt in 3.9 years and reduce the interest paid to about $3,339 (assuming an 8% APR).
- Debt Consolidation Program. Under a DCP, the monthly payment would be about $462.92 and take about 4 years to pay off—and may very well eliminate interest payments.
Of course, there’s always some room for variability depending on the creditor or the bank you deal with. For example, a bank might offer an even lower APR rate on a consolidation loan—allowing you to pay off your debt faster and with less loss to interest than stated here. Or, a creditor might not be willing to negotiate away your interest when you enter a DCP.
This is why it’s important to investigate all of your options before choosing a method for consolidating your debt. In some cases, you may even want to consider filing for insolvency with a licensed insolvency trustee (LIT) if you are drowning in debt that you cannot conceivably recover from.
Need help finding the best way out of debt? Credit Canada is here to help you. Our experienced and compassionate credit counsellors are here to give you the nonjudgmental support you need to get out of debt and get back to your life. Reach out today to get started!