When you’re juggling monthly payments to multiple creditors, the idea of making one payment towards the entire amount owed may sound like a huge relief, or too good to be true. However, if you’re struggling with overwhelming debt, making one monthly payment to all your creditors may be an option. The process is called debt consolidation, and there are typically two ways to go about doing it: consolidation loans and Consumer Proposals.
A debt consolidation loan is essentially a personal loan granted by a bank or lender which allows you to make one smaller monthly payment on combined loans, credit cards, lines of credit, and other debts, typically at a lower interest rate.
If you are considering a consolidation loan, you must meet the requirements of the lender. They generally are:
- A good credit score (typically 630 or higher)
- A sufficient credit history that reflects good behavior with credit
- Enough income to pay off the loan in 3 to 5 years
- A total debt service ratio of typically less than 35%
If you are unsure of what your debt service ratio is, don’t worry, most people don’t. Your debt service ratio is a measurement that shows the percentage of your monthly gross income needed to make all of your debt payments, including payments for your vehicle and home.
(Your Total Debt Amount ÷ Your Monthly Gross Income) x 100 = Your Debt Service Ratio
For example, if your gross monthly pay is $3600 and your debt payments total $2000, the resulting debt service ratio of 55 percent. This is likely going to work against you when qualifying for a consolidation loan. Although debt service ratios may vary by lender, 35 percent is a good initial guideline.
The existence of ‘other’ significant debt you’re carrying could make a consolidation loan completely out of reach or unrealistic. Consolidation payments must be affordable. A comprehensive review of your budget beforehand is a critical step in your decision to proceed. You also need to have realistic expectations in your ability to put a halt on using credit during the term of the consolidation loan. If you are incurring new debt after you’ve consolidated, it will derail your initial good intentions of tackling your debt quickly and at a lower cost.
Consolidating debt under a Consumer Proposal applies the same concept of merging all debts into one payment; however, that’s where it’s similarities to a consolidation loan end. Unlike a consolidation loan, a Consumer Proposal is not funded by way of monies loaned to you, but from the amount you can afford to pay according to your budget. In Canada, Licensed Insolvency Trustees are the only authorized administrators of Consumer Proposals, not banks, lenders or lawyers. If you file a Consumer Proposal, monthly payments are paid over a maximum 60 months or 5 years; but can be paid off sooner without penalty.
While with consolidation loans, tackling your debt can easily be derailed, as you can apply for credit credits and lines of credit will paying off your other debt, this is simply not possible when consolidating under a Consumer Proposal. Under a proposal, all credit card and line of credit accounts are cancelled, and your credit rating will be reduced to an R7 rating, making it more challenging to apply for credit during the term of the proposal. Other significant differences between consolidation loans and Consumer Proposals are that with a Consumer Proposal, you actually pay back less than the total amount you owe and you are paying it back at no interest rate.
You may be thinking this seems too good to be true. Why would creditors agree to get paid less than what they are owed, while also terminating their interest? They agree to it, because a Consumer Proposal is administered as a formal process governed under federal rules and immediately freezes all creditor action to collect on the debt. They also typically result in a higher recovery to your creditors than they would see under a bankruptcy. The Consumer Proposal process requires participation from the creditors, as they vote to accept or reject your offer to repay a percentage of the debt. Once accepted, the creditors consider your debts fully settled once all payments in the proposal are paid by you in full.
If you would like to learn more information about debt consolidation and other debt relief options available to you, contact one of our debt professionals for a free, no obligation consultation.