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What is Debt Consolidation and Should You Do It?

21 July 2022Tassie Milne 4 min read
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If your bills and debts are starting to feel overwhelming, there might be a better solution besides tracking every single payment on your calendar or having multiple automatic payments: it may be time to consider debt consolidation.

While the name might hint you have the option to combine existing debts into one solid place, it’s a little more complicated.

In reality, because of the various interest rates you can have on your credit cards or loans, it’s nearly impossible to combine all the debt into one place—however, there are some workarounds.

Ultimately, debt consolidation is when you combine multiple debt balances into one single loan, which you pay off with fixed monthly payments.

This can be done through offerings by banks and credit unions, or by also using new loans to pay off existing ones. A prime example is to open up a line of credit and use that money to pay off your credit card debt, and then paying off the line of credit with monthly installments. Although it might seem counterintuitive to pay off loans, with even more borrowed money, there are actually a lot of benefits to this approach.

When it comes to debt consolidation, depending on your credit score, you may have a couple of different options to choose from:

A home equity loan/line of credit

For those of you who already own at least a single property, depending on your home’s current equity and your income, you may have the option to pull a second mortgage. These also often have low-interest rates.

A line of credit

If you’ve got a good credit score, chances are your bank may be willing to approve you for a line of credit. This line of credit is similar to a credit card and can be used to pay bills or be transferred to other accounts. The only caveat is, if using this method, you have to be disciplined in paying off more than just the monthly minimum, as it will take years to pay it all off if you only stick with the latter.****

A debt consolidation loan through a bank or credit union

Similar to a line of credit, if you’ve got a pretty great credit score and security for the loan, you can often get this type of loan through your bank or credit unit. In comparison to a Home Equity Line of Credit or a Line of Credit, this loan generally has the next best interest rate, after the two.

A low-interest rate credit card

If you’re struggling to get a bank or credit union to approve you for a loan, you could also try consolidating your debt onto a low-interest credit card. Like a line of credit though, you truly need to exercise discipline in ensuring you pay off more than just the monthly minimums to keep you on track to paying it off faster.

If you’re combining all your debt into one place, doesn’t that add up to the same? Yes—but also no. Thanks to a newer—and potentially lower interest rate—you may actually find that your payments will be less each month, ensuring you can stay on top of your finances. But need a little bit more of e a reason? Look no further. Thanks to debt consolidation:

  1. You can simplify your finances. Instead of having to track multiple debt payments—including the management of different rates and payment dates—you can just keep track of one larger debt payment every month. It’s a great way to also ensure you stay on top of your payments, with less chance of missing a due date.

  2. You can make your life easier with a smaller monthly payment. Even better: based on how long you decided to have this loan—also known as the amortization period—and the interest rate, you could actually have smaller monthly payments.

  3. You might get a lower interest rate. If you can get approved for a low-interest rate consolidation loan, you can pay off your high-interest debt with this rate—which means you can also save a little bit of your money in the long run.

  4. You can pay off debt faster. However, this only works if you obtain a lower interest rate and keep your current monthly debt payment pretty much the same as it is now. This then allows more of your monthly payment to actually pay down your debt (the principal) since less of the money is being eaten up by interest.

  5. You can also improve your credit score. As we all know by now, the more you pay your credit, the more you’re buffing out your credit history. With that in mind, by making these easy monthly payments, you’re working towards increasing and/or maintaining a good credit score. While, it should be known that a debt consolidation loan does require a hard credit check—which may decrease your score—keeping up with your payments will pay off (pun intended) in the long run.

  6. You will improve your cash flow. Now that you’ve put all your debt into one payment plan, you might have a bit more wiggle room with your cash on a monthly basis, giving you more opportunities to save and budget accordingly.

Still unsure if you should consolidate your debt? It truly depends on your circumstances. Factors to consider are:

  1. Your Credit Score: If you have a good credit score, there’s a better chance of you securing a much lower interest rate for your debt consolidation loans

  2. Whether you prefer fixed payments: Ask yourself if a fixed interest rate, repayment term, payment schedule, and interest rate are what you’re really looking for. And if you answered yes, then this may be an option for you.

  3. You can repay the loan: There’s no point taking out a new loan if you’re unable to pay it monthly. Only truly consider debt consolidation if you can afford to pay it. If not, you’ll put yourself at risk for negatively impacting your credit score and overall finances.

At the end of the day, how you maintain your finances is truly up to you. But, if you choose to pursue debt consolidation, it’s important to not use it as a crutch. While these debt consolidation loans are great for helping you get out of some pickles, it’s just as important to reign in your spending habits or come up with a more effective budget, to help you stay financially on track.

And if you need help to ensure you’re staying on track when it comes to maintaining your credit score, why not check yours out today? Get it in minutes—plus it’s free, forever.

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Written by Tassie Milne

General Manager - ClearScore Canada

Tassie heads up ClearScore Canada. She lives in Toronto with her husband and two young boys. In her free time, she can be found at the family lake house or playing ball hockey.