You find yourself in a situation where the monthly payments required on your various credit cards have stretched your budget beyond its limit. Instead of making monthly payments on high interest credit cards, you consider obtaining a consolidation loan that you hope will reduce the interest costs and the monthly payments.
At first glance, a consolidation loan may be viewed as a solution to your financial problems. But be aware that not all consolidation loans are created equally and without taking corrective action regarding your spending habits, they may become a diving platform for financial disaster.
Generally, the more favourable consolidation loans provide a borrower with a financial tool to consolidate multiple payments into one lower monthly payment and thus eliminate the juggling of bills and the "borrowing from Peter to pay Paul" dilemma faced by an individual.
Hopefully, an added bonus of the consolidation loan is a reduced interest rate which will allow for the repayment of the loan in a reasonable period of time and get you back on the path of financial health.
To obtain a consolidation loan at normal retail banking interest rates, a lender typically will look at, among other things, an individual’s credit rating, the assets that an individual may be able to pledge as security for the loan and the individual’s ability to make the monthly payments on the loan. After considering these and other risk factors, the lender will either grant or refuse the loan and if granted will set the interest rate based on its assessment of the risk.
The lender may also request that the loan be guaranteed by a friend or relative who has a stronger credit rating than the primary borrower.
If your situation is such that you do not qualify for a consolidation loan from a traditional lender, you may have considered looking to other high interest lending sources to obtain the debt relief you desire. After assessing the risk factors, these lenders may provide you with the consolidation loan but they may require that you pledge whatever assets you have (household furniture, vehicles, property etc.) and they will charge a high interest rate which may be equal to or greater than the interest rate being charged on the credit cards. Your monthly payment may be reduced but the high interest rate may make repayment of the loan very difficult because substantially all of your monthly payment is being applied to interest charges.
There is still another option to consider for consolidating your debts and it will likely come at a much lower cost.
Under the Bankruptcy and Insolvency Act, there is a process known as a consumer proposal that is available to individuals with unsecured debt of $250,000 or less.
Under a consumer proposal, you would make a formal offer to pay your creditors in full over a period of five years or such shorter time as you and your creditors may agree.
A consumer proposal has the advantages of stopping the accumulation of interest charges, reduces your monthly payment and would not require you to pledge assets as security. There is a cost to have the consumer proposal administered but this cost is included in your monthly payments and is in effect borne by your creditors. The cost will likely be significantly less than the additional interest charges you incur by utilizing other debt consolidation alternatives.
Your local trustee in bankruptcy can explain in greater detail how a consolidation of your debts can be achieved through a consumer proposal.
Debt consolidation can help you alleviate your monthly budget challenges and provide a mechanism to deal with your high interest rate debts. But to be effective they should be done in conjunction with making a change in your spending habits.
Your objective should be to improve your financial position after consolidating your debts and not treat the consolidation loan as a diving platform to incur more debt.
» Wayne K. Palmer is a senior manager in BDO’s Brandon office. He is responsible for both the consumer and commercial practices in Brandon and surrounding areas, including Boissevain, Minnedosa, Neepawa and Dauphin. Wayne has more than 25 years experience in the financial recovery services field.