What Do You Mean By Debt Consolidation?
About once a week I’ll answer my phone and hear the following…
“Hi, yes, I’d like to chat with you about consolidating my debts…do you do that?”
At this point I know I’m going to have to provide some clarity. I usually suspect the person I’m speaking with is actually interested in a Consumer Proposal, and not a Consolidation Loan. This is especially the case if they were referred to my office. However, I have to make sure as many people think in terms of loans when it comes to seeking debt help, and someone who is looking for “consolidation” may be looking for a consolidation loan.
Both a Consolidation Loan and Consumer Proposal are forms of consolidation. In both cases, different debts are packaged into a single serving, so to speak, and a single, regular payment is made monthly. The process and subsequent results of obtaining a consolidation Loan vs filing a consumer proposal are quite different though.
Consolidation Loan
Let’s say you owe $30,000 on five different credit cards. The interest rates on the cards are likely to vary considerably. One card may charge 19.99%, another 24.99%, maybe two charge 29.99%, and the last one is over 30%. Long story short, you’re paying a lot of interest. Huge interest! In fact, the interest is so immense every time you pay your bill the amount you owe barely moves. Faced with this situation, many people will look to obtain a consolidation loan. The loan serves two purposes…
- The loan proceeds are used to pay off the five credit cards. Now instead of having to pay five different bills, you only have to pay a single bill monthly. You have consolidated your debt
- The consolidation loan likely has a much lower interest rate than your credit cards. Most consolidation loans I’ve seen lately feature an interest rate of 12.49% and are spread over five years. As a result, your monthly payments are likely less than before and each payment results in a decrease in the amount owed.
That’s the theory, at least. While the above scenario is certainly preferable to holding five credit cards with a total of $30,000 of debt, consolidation loans have their challenges.
Approval
It is very difficult to get approved for a consolidation loan. Why? Well, try to imagine this situation from the lender’s perspective. You’re asking the lender to provide you with a $30,000 unsecured loan so you can pay off debt. The lender will assume all the risk, which is quite high considering you were in debt to begin with.
The lenders in this case tend to be banks, and banks are risk averse. Banks usually won’t provide a consolidation loan unless they feel the loan has a high likelihood of being paid. Banks also don’t like to pay off other banks’ debts. If you owe $5,000 to TD and you’re sitting in RBC asking for a consolidation loan, RBC will be hesitant to give you money to pay off their competitor.
Unmanageable Payments
It’s important to remember that a consolidation loan does not eliminate debt. It simply converts one type of debt into another. If you owe $30,000 on credit cards and obtain a consolidation loan in order to pay off those cards, you still owe $30,000!
A $30,000 loan at 12.49% interest over five years results in a monthly payment of $675.That figure is likely lower than what you were paying previously, but is it manageable? For about 70% or more of applicants, the answer is no. Moreover, consider the full pay back. Paying $675/month over five years gives us a grand total of $40,500! What was a debt of $30,000 now requires $40,500 worth of payments to eliminate. That’s a tall order for a majority of people.
Consumer Proposal
Let’s stick with our scenario above. You owe $30,000 on five different credit cards. As above, we can consolidate the five cards into a single payment. The key difference with a proposal though is that instead of paying back $30,000 plus interest, we’re going to pay back less than $30,000, and without any interest.
Proposals vary as the amounts offered to creditors are based on the debtor’s income, assets, household size, and a host of other factors. However, an example of a realistic offer could be $8,100 over five years at zero percent interest. The monthly payment for such an arrangement is $135 per month.
Comparison
$675/month vs. $135/month, a difference of $540/month and a difference in payback of $32,400.
From a pure numbers perspective, the preferred arrangement is obvious. Who wouldn’t want to save $32,400? Are there other factors to consider? Yes. A proposal does negatively impact one’s credit. However, as I have explained in previous posts and intend to continue to explain in future posts, credit can be rebuilt and rebuilt fairly quickly using our credit rebuilding program and tools.
In my mind, temporarily damaged credit and an extra $32,400 in your pocket is preferable to the alternative – assuming you can even get approved for the consolidation loan in the first place.
To sum things up, when speaking of ‘consolidation’, it’s important to distinguish between Consolidation Loans and Consumer Proposals. While similarities exist, the requirements and ultimate result often differ tremendously.
One thing to remember is Consumer Proposals can only be filed by a Trustee in Bankruptcy but Trustees represent your creditors. 4 Pillars Consulting, on the other hand, represents consumers and works to level the playing field working to get consumers the best possible deal when dealing with their debt.
About the Author:
Zach Brull operates the 4 Pillars Markham, On and Scarborough, On Debt Restructuring office. To contact him directly visit his website or call him directly at : 289-466-1029
