You may have heard that debt consolidation loans can help you get on top of unpaid debt. But you might have questions about how debt consolidation works and whether it would be right for you. To answer these questions, we teamed up with our partners at Fairstone, a responsible Canadian lender since 1923. Here are your top 5 questions about debt consolidation answered.
How does debt consolidation work?
With debt consolidation, you take out a new loan equal to your unpaid debt and use the new loan to pay off the existing debt. Essentially, you’re combining (or “consolidating”) existing debts into a single loan so that you can focus on making a single monthly payment.
For example, let’s say your total debt is $18,500, but each bill has its own interest rate, payment amount, payment deadline, and time to pay off.
Before a debt consolidation loan:
| Credit card 1 | Credit card 2 | Personal loan | Retail store financing | |||
| Interest rate | 19.99% | 19.99% | 31.99% | 29.99% | ||
| Balance | $7,500 | $5,000 | $4,000 | $2,000 | ||
| Initial monthly payment* | $225 | $150 | $174 | $60 | ||
| Total debt
$18,500 |
Total monthly payment
$609 |
Months to pay off
430 |
||||
With consolidation, you’ll take out a loan for $18,500, pay off the old debts, and are left with one monthly payment at a set payment amount each month – less to remember, and the new loan clears away the old debts.
After a debt consolidation loan:
| Fairstone debt consolidation loan | ||
| Interest rate | 19.99%** | |
| Balance | $18,5000 | |
| Fixed monthly payment | $345 | |
| Total debt
$18,500 |
Total monthly payment
$345 |
Months to pay off
120 |
In the example here, you could save $264 a month and be debt-free in half the time it would take without a consolidation loan.
When and why should I consider consolidating debt?
Suppose you have several outstanding debts with various payments and interest rates; you frequently make the minimum payment or only small payments on these debts and are ready to get out of debt. In that case, it’s time to consider debt consolidation.
Why consolidate? You could:
- Experience relief from paying off outstanding debt, particularly anything that is past due or already in collections
- Gain the simplicity of a single payment with a set amount each month
- Save money on interest in the long term
- End up debt-free sooner than you would with minimum payments on a credit card
Will I save money with debt consolidation?
You’ll likely save money with debt consolidation if you’re currently making minimum payments on revolving debts (like a credit card) or falling behind on bills and higher fees. You’ll benefit from reducing accruing interest charges (by clearing away the old debt) and reducing the time it takes to pay off your total debt.
You’ll likely also save money on your monthly payment. Rather than juggling several payments on different dates, a debt consolidation loan will give you a single, consistent payment amount on a set schedule. Since the loan amount will be spread out over the loan term (ranging from 6 months to 10 years), you can reduce monthly payment amounts.
Tip: You can also calculate how much you’ll pay in accrued interest charges if you make minimum or small payments using Government of Canada’s credit card calculator.
What can I use for debt consolidation?
Borrowers usually use a loan or line of credit to consolidate debt as these options offer:
- Access to more money (enough to cover all of your debts)
- Lower rates than all or some of your debts
- Set loan terms to enable a regular payment schedule
Homeowners can consider using a secured loan or home equity line of credit (HELOC) to pay off debts. Secured personal loans give borrowers access to more money at a lower interest rate than unsecured personal loans.
Will debt consolidation help me improve my credit?
Debt consolidation can start a new chapter in your credit history. You will pay off your old debts, and you can focus on demonstrating positive payment behaviour while paying off your debt consolidation loan. Maintaining your payment schedule, making payments in full, and making extra payments when possible will improve your credit score.
Better credit doesn’t happen overnight, but during the term of your consolidation loan, you have a real opportunity to establish new money management routines. You’ll want to avoid repeated late or missed payments and unnecessary spending.
What do I do next?
If you’re ready to get rid of debt of all the short term loans you have accumulated, debt consolidation may be the right option for you. Start by, adding up how much money you owe – the balances on any credit cards, unpaid bills, financing programs, etc. (not including your mortgage). Next, request a quote for a consolidation loan so you can determine if consolidation is the right option for your debt situation.
Visit Fairstone.ca for a loan quote telling you how much money you can borrow and what your payments might be – no obligation, and no impact to your credit score.
*Illustration only. Monthly payments shown are minimum payments. Payments would change over time based on balance and payment history.
**Rate and amount apply to secured personal loans. Rates may vary. Complete a loan application for personalized results.
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