The truth is the right debt relief solution always depends on your circumstances. In this guide, I’ll provide a comprehensive comparison of debt consolidation vs debt settlement to help you determine which option is best for you.

What are the differences between debt consolidation vs. debt settlement?

Debt consolidation is a process of transferring existing debts into one larger loan or repayment plan. There are several ways you can do this. You can get a personal loan through your bank, credit union or other financial institution. You can use a balance transfer credit card to move balances from your current credit cards to a new card with a lower interest rate.  You can consolidate credit card debt and other bills into a second mortgage or home equity line of credit.  You can also enroll in a debt consolidation program with a credit counselling agency, although a debt management plan is more of a repayment program than a consolidation loan.

As you can see, each of these options means moving debts around. No matter which approach you use, debt consolidation does not reduce your overall debt load. You still must pay back everything you owe.

In the case of debt settlement in Canada, a Licensed Insolvency Trustee works with you to present a proposal to your creditors to accept a lower payment and settle your account. This is a method typically used by Canadians who find themselves unable to make payments on their outstanding debt. The amount you pay back is reduced, with your settlement amount usually paid out monthly over up to five years.

Pros and cons of debt consolidation

Debt consolidation is appealing because it simplifies money management and can save you money.

Some key benefits of debt consolidation include:

• You simplify the way you pay your bills. You make a single payment to just one lender with one deadline every month instead of juggling multiple due dates to multiple creditors.
• You get a lower interest rate. Most consumer debts are the result of credit card bills with high interest rates. When looking for a debt consolidation loan, look for one with a lower interest rate. This way, you can get out of debt sooner because you are paying more towards principal with each payment and less in interest.
• Your monthly payment will be lower. In addition to a lower interest rate, you can choose to lengthen the term of the loan, which gives you more time to repay your debt and lowers your monthly payment. A lower payment can help you balance your budget so you can keep up with all your bill payments.
• It can increase your credit score. Even though debt consolidation solutions may hurt your credit score in the beginning, making timely payments will help you increase the score gradually. If you keep the old credit cards that you paid off through consolidation, your score will recover even quicker because this reduces your debt utilization ratio. Just remember to use the credit cards sparingly, so you don’t go back to square one.

Debt consolidation doesn’t come with advantages only, though. There are risks with a debt consolidation loan. By consolidating your existing debt, you are simply transferring all the debts you have into a new account that has an extended-term to pay it all off. This means that you can get in trouble if you miss making payments or continue to spend on your credit cards and rack up more debt.

Some disadvantages of debt consolidation include:

• The debt remains the same. Your total debt is not reduced or forgiven, so you’ll owe the same amount of money. The only difference is that you’ll only have one creditor. If you consolidate your debts but don’t decrease your spending, your financial situation will continue to deteriorate.
• You can’t consolidate effectively with a poor credit score. To qualify for a consolidation loan at a low interest rate, you will need to have a good credit score. If your credit is poor, your interest rate might be the same or higher, which gets you nowhere.
• If you don’t keep up with payments, creditors can sue to collect. If you default on your consolidation loan or balance transfer card, your creditors can take legal action against you, which may result in your wages being garnished and, if you have a secured loan you could lose your home or have your car repossessed.

Pros and cons of debt settlement

When you settle your debts, your creditors agree to accept less than you owe and forgive the remainder of your debts.

If you have decided that settling your debts is the right option for you, make sure you do it right. There are two ways to negotiate a debt settlement in Canada. One of them is via private debt settlement companies that offer debt settlement programs, and the other is by working with a Licensed Insolvency Trustee to file a consumer proposal.

Unlicensed debt settlement companies usually don’t work well, mostly because many creditors won’t negotiate with them. They often advise that you stop making payments towards your debts in the hope that you’ll eventually reach an agreement with your creditors. The danger of working with a for-profit debt settlement company is that your creditors won’t wait and will pursue you legally to collect. They can garnish your wages or freeze your bank account without the formal, legally binding creditor protection that a consumer proposal or bankruptcy can provide.

In Canada, the most common way to consolidate debts is through a consumer proposal filed with a Licensed Insolvency Trustee.

The main benefits of settling your debts with a consumer proposal include the following:

• You avoid bankruptcy
• You get protection against creditor actions
• Your monthly payment is much lower
• Payments are fixed, unlike in the case of bankruptcy
• You get to keep all your assets

The main disadvantage of any debt settlement program is that it does have a negative impact on your credit score.  You will find it difficult to access credit for a while, although some people are able to get a new credit card within a year of filing.

Consumer proposals don’t affect any of your secured debt, such as your mortgage or car lease, which means that you’ll still need to make payments regularly to keep those assets.

To file for a consumer proposal, you need to make an appointment with a Licensed Insolvency Trustee, who will analyze your financial situation and discuss all available options with you. If you determine settling your debts through a consumer proposal is the best option for you, the trustee will help you prepare and file it for you.

Consumer proposals are legally binding debt settlement agreements. Once filed, you no longer need to deal with collection calls, and wage garnishments stop. All you unsecured creditors are bound by the same agreement, as long as the majority of your creditors agree to your terms.

Do debt consolidation loans hurt your credit score?

The answer is it depends. If you consistently make all your monthly payments on the debt consolidation loan on time, there should be no negative effects on your credit rating. Applying for a new loan may result in a short-term dip in your credit score. However, it will slowly go up again once you start making payments.

It is also possible for your credit score to improve. The reason is a debt consolidation loan can help you improve some of the factors that credit bureaus use to calculate your credit score.

A consolidation loan can help your score by:

• Improving your credit utilization as you move away from maxed-out credit cards. Of course, this is assuming you don’t drive up those balances again.
• Help you build a better payment history, especially if you previously made late or missed payments. Your old bad habits will age, have less impact on your score, and eventually fall off your report in six years.
• Improving the type of debt you have by converting revolving credit balances, like credit cards, to a term loan.

What is the effect of debt settlement on the credit score?

Debt settlement might be the best option financially if you’re struggling with debt, but your credit score will take a hit. How much of a decline depends on your situation going into the program.

If you are already behind on payments or have maxed out your credit cards, you already have a bad credit history and likely a low credit score to match. Even if your score is good, if you cannot afford to repay your debts, you risk defaulting on debts in the future. You may also not qualify for a debt consolidation loan, even with a good credit score, because you carry too much debt.  Most lenders view having a high debt-to-income ratio is as bad as having a poor credit score.

You may be wondering why debt settlement should harm your credit score when your creditors are getting some of their money back, and you’re reducing your total debt. The answer is that credit scores reward accounts that have been paid according to the original credit agreement and on time before they’re closed. In the case of a debt settlement plan, the original agreement is modified when you agree to pay back a portion of the outstanding debts. As a result, credit bureaus modify your score downward while you are in a debt settlement program. 

Having said that, creditors and the credit bureaus do look on programs like a consumer proposal better than a bankruptcy, where your debts are wiped out entirely.  That is why debts in a consumer proposal are coded as an R7, while debts in a bankruptcy are coded as an R9.

Making a deal with your creditors is about getting rid of debt you can no longer repay.

You can begin to rebuild your credit history and show a new ability to handle debt wisely once your old debt is gone.

Should you use debt consolidation or debt settlement?

It is always better to pay all your debt in full if you can. However, life events happen – a job loss, income reduction, divorce, or illness – and these often lead to more debt than you can afford to repay.  It is also true that a significant number of Canadians are living paycheque to paycheque, and just one sudden expense can mean more debt. When this is high-cost debt like a payday loan or high-interest instalment loan, this can create a cycle of debt that is hard to manage on your own.

Whether debt consolidation or debt settlement is a better solution for you depends on your finances.

Initially, you will want to see if you should get a debt consolidation loan.

To qualify for a debt consolidation loan, you must meet three basic lender requirements:

• You must have a reasonably good credit score – generally in the low- to mid-600s
• You must have sufficient income to support your loan payments
• You may need assets, such as some home equity, to provide as collateral

The higher your credit score, the lower your debt-to-income ratio and the more collateral you can provide, the lower your interest rate will be.

If you do not have any assets to get a secured consolidation loan, you can apply for an unsecured consolidation loan.  These types of loans are considered higher risk and come with very high interest rates.

If your credit score is below 600, it is unlikely that you will qualify for a debt consolidation loan at any reasonable rate.

If you do not qualify or cannot afford a debt consolidation loan, your next option will be to consider making a proposal to your creditors.

Debt settlement or a consumer proposal is an option that is best suited to individuals who:

• cannot meet their current minimum debt payments as they come due
• do not qualify for a debt consolidation loan
• cannot afford to repay their debts in full
• have a minimum unsecured debt amount of $10,000 or more
• have enough income to pay back a portion of what they owe

The goal of debt settlement is to make your life easier by getting rid of some of your debt so you can balance your budget and stop relying on debt to survive.

Debt consolidation and debt settlement advice

Debt consolidation and debt settlement are both solutions that improve your financial situation by helping you deal with overwhelming debts, but they work in different ways. In summary, debt consolidation is useful for reducing the number of creditors you owe and lowering your monthly payment, while debt settlement works for those who want to reduce the total amount of debt they owe.

If you have a lot of debt and are looking at options to help you eliminate that debt, book a free consultation with a Licensed Insolvency Trustee. Our role is to help you review all debt relief options’ pros and cons and help you gain a fresh financial start.

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Advantages and disadvantages of a joint application

When you apply for a joint debt or loan as a couple, you are saying to the lender: we would like to use our combined credit capacity, and our combined income, to support our loan application.

There are advantages to applying together for a debt consolidation loan.

• If one spouse’s debt-to-income ratio is too high, you can use the income of the second spouse to improve this lending factor.
• Similarly, if one partner has a bad credit score, the application may be approved on the merits of the second co-applicant or cosigning spouse.
• By improving the quality of your application and overall creditworthiness, you may qualify for a lower interest rate loan than the high debt spouse can acquire.

While you can borrow more money with a shared application, the downside is that as co-borrowers, you both will be legally obligated to repay the loan.

A joint debt creates what is known as a ‘joint and several’ liability. Both parties are 100% liable to repay all the debt. This can create significant financial risk for the spouse that is now assuming responsibility for debts created by the other spouse.

Credit score issues

Lenders are in the risk management business. To qualify for a low rate consolidation loan, at least one applicant will need a good credit score. You are relying on the positive credit history of one spouse to override the negative history of the other.  However, making a joint application means that the debts that were affecting your spouse’s credit score will now impact yours. 

• Your credit score may fall because you have taken on new credit.
• Multiple applications create hard hits on your credit report that can also hurt your credit score.
• A new loan can also increase your credit utilization ratio until you begin to pay down the consolidation loan.

Marital breakdown

Joint debt means you are responsible and liable under the terms of a signed loan agreement. It doesn’t matter who says they will pay the loan. If you divorce or separate from your spouse, and they stop making payments, the lender will look to you to repay the debt.

Debt cannot be allocated in a divorce or separation agreement. While your separation agreement might call for a 50-50 split of debts, or your spouse might agree he will make the monthly payment because the debt was his originally, the agreement between the two of you has no legal impact on your lender.

Further, it is not possible to have a name taken off a joint loan without the lender’s permission, and because the lender approved the loan based on a joint application, they may not be willing to do so. In the event of a marital breakdown, you could be left with payments you can’t afford.

Marital assets and property

Another factor to consider is whether you want to risk any family assets to consolidate unsecured debt like credit card debt.

Converting unsecured debt into a secured consolidation loan is one of the riskiest consolidation strategies we see.

If you are fortunate enough to own a home, a home equity loan, or home equity line of credit can seem like an attractive loan consolidation approach to deal with one spouse’s problem debt. However, merging family debt into your mortgage creates two financial risks; you are now liable for larger mortgage payments and, if you and your spouse default, you risk losing your home.

Income stability

One of the most common reasons people find themselves unexpectedly filing a bankruptcy or consumer proposal is a job loss or income reduction. Consolidating debts with your spouse means you are both equally responsible. If one spouse loses their job, you may no longer have the income capacity to keep up with your consolidation loan payments. The option for one spouse to file bankruptcy to deal with their separate debt, leaving the other financially stable, is off the table once you agree to consolidate your debt legally.

Student debt

With student loan debt is a growing issue among millennials, many are entering their marriage years already in debt. Today 1 in 5 of our clients carry student loan debt, and this rate is growing rapidly. If one spouse has been unable to earn enough to repay their student loans, it may make more sense for them to consider student loan relief options rather than burdening the two of you with ongoing loan repayment.

Student loan consolidation is also not always a good idea as you can lose the tax benefits of the deductibility of interest on Canada student loans.

Is a joint loan the best option?

Problem debt is problem debt. It may not make sense to shift bad debt to your partner. This may not help either of you get out of debt.

The reason most couples consider a joint consolidation loan is to use the good credit history of one spouse to help the other deal with overwhelming debt. However, if one spouse is experiencing financial hardship because of their loan payments, burdening the second spouse with the same joint legal obligation may not be the best course of action.

Before consolidating one spouse’s bad debts into a family debt, it may make more sense for the spouse with debt issues to talk with a Licensed Insolvency Trustee about loan forgiveness. The spouse with high consumer debt may want to consider filing a bankruptcy or consumer proposal as a form of debt relief rather than transfer the debt obligation to the other.

There is a secondary benefit in keeping personal responsibility for personal debts. This can preserve the credit rating and credit capacity of the spouse with good credit for future needs. That spouse can still qualify for a mortgage while both spouses save money for a down-payment after completing a consumer proposal, for example.

Filing insolvency does not affect your spouse’s credit. This is one of the common misconceptions of how a bankruptcy filing impacts a spouse. The spouse filing insolvency can work to improve their credit without harming the credit of their partner.

In the end, you must decide as a couple about consolidating your debt through a joint loan. Talk together about how and who will make the monthly payments, what happens if your finances or relationship changes, and how refinancing with a joint consolidation loan will affect your future financial goals.

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How do car title loans work?

Just as it sounds, a car title loan is a personal loan secured against the value of your vehicle. Applying for a title loan is easy, can often be done online, and may not even require a credit check, which is why car title loans are attractive to someone with low or bad credit.

As a secured loan, vehicle title loans use the value of your car to secure payment. The lender will register a lien on your vehicle, which will remain until the loan is paid in full.

To qualify, you must own your vehicle outright, have a valid driver’s license and car insurance. You do not however need a good credit score although the better your credit history the lower the rate will be on your loan offer. You will also need to provide the loan provider with proof of income or employment to show that you can afford the loan payments.

The lending company will ask for the make, model & year of your vehicle, and mileage to confirm what the car is worth. You can usually borrow 25% to a maximum of 50% of the vehicle’s estimated appraisal value.

Why would you get a car title loan?

There are many reasons why people apply for a vehicle title loan. As mentioned, it is an attractive debt consolidation loan option for those with poor credit. You might use the money to pay off overdue bills or pay down credit card debts or consolidate payday loans.

There can be benefits of consolidating your debt with a loan against your vehicle:

• It can help with monthly payments. Instead of juggling several overdue accounts, you now have one monthly payment on your car loan.
• You might get a lower interest rate. Because it is a secured loan, a title loan may have a lower rate than unsecured loans or other low credit score products like a payday loan. However, these loans are still high risk and can carry an interest rate of 35% plus additional fees.
• It can help improve your credit score. A title loan is an installment loan that, when reported on your credit report, can improve your credit history if you make your payments in full and on time.

The problem is many people use title loans as an alternative to a more traditional payday loan when in need of quick cash. I would caution against borrowing against your vehicle because you need money to pay for everyday living costs or unexpected expenses. While cheaper than a traditional payday loan, this is still a temporary fix to a cash flow problem.

What are the disadvantages of title loans?

As mentioned, car title loans can be very expensive. Rates of 35% and even 49% are not unusual, and administration and valuation fees can add several hundred dollars to the amount you have to repay.

However, the biggest disadvantage is the potential repossession of your vehicle.

If you can’t pay back the loan, your lender can:

• Charge additional NSF fees and interest penalties for late payments
• Place a negative mark on your credit report
• Seize and sell your vehicle to recover the remaining balance owing
• Sue you for any shortfall on the loan

We have filed bankruptcies and proposals for people who have taken out a title loan on top of credit card and other debts, only to see them lose their car because they could not repay the loan. This was an unnecessary loss since the debts they paid off with the proceeds of their title loan would have been discharged by bankruptcy and in most cases, they would have kept their vehicle since it was worth less than the allowable exemption limit.

Another concern is what happens if you still owe money on the loan when you want or need to replace your vehicle. You will be required to pay off the balance or roll-over the remaining loan into your new loan, which can lead to further debt problems.

Car loan:
Cost of goods: $25,995
Cost of borrowing: $18,297
78 month term
Total owing: $48,768
Current black book value of car: $13,775

— Scott Terrio (@ScottTerrioHMA) February 7, 2020

Alternatives to consolidating debt with a car title loan

You may want a loan to pay off existing debt or bills but refinancing your car may not be the best solution.

There are other options to consider.

• Obviously, it’s time to review your budget to figure out ways to pay down debt, not just move the debt around.
• Apply with more traditional lenders first, like a credit union, to see if they will provide you with a less expensive loan.
• Even taking out a cash advance on your credit card or going into overdraft on your bank account can be a cheaper alternative, with less potential downside, than taking out a title loan.
• If you are behind on a few bill payments, ask your creditors for extra time to pay or work with a credit counselling agency to arrange a payment plan.

If you already owe more debt than you can pay, and all you are doing is buying time with a short-term title loan, a better option may be to talk with a Licensed Insolvency Trustee about real debt relief options like a consumer proposal. The sooner you talk to a trustee, the more consolidation options you have.

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Should you consolidate your debt with a new loan or through a debt management plan with a credit counsellor?

And at what point are your debts too large for either of these consolidation options to be successful? When should you consider a consumer proposal or bankruptcy as a form of debt relief if your financial situation is more severe?

What is a debt management plan?

A debt management plan, or DMP, is a consolidation program arranged through a non-profit credit counselling agency where you make one manageable monthly payment to pay off certain unsecured debts. Your credit counsellor negotiates an agreement with your creditors to include your debts in the program and may also be able to arrange an interest reduction or interest freeze.

How does a debt management plan differ from a loan?

Credit counselling agencies do not lend money. A debt management plan may consolidate your payments, but it is not a new loan. Unlike with a debt consolidation loan, you are not transferring balances from one creditor to another when working with a credit counsellor to repay debt. You still owe each individual creditor while you are in the program.

There are advantages to consolidating your debt with a debt management plan over a consolidation loan:

• You do not need a good credit score to qualify
• You do not need any security to offer as collateral
• You will not need a cosigner
• A DMP can lower, and perhaps even eliminate, your interest costs, saving you money
• Your credit counsellor will negotiate directly with your creditors, so you don’t have to
• Credit counsellors provide additional advice and support on budgeting

While there is no interest rate with a DMP, an additional fee of approximately 10% of the debts consolidated in the program will be added to your monthly debt payments.

Since you are not paying existing debts off with the proceeds of a new loan, some creditors may decide not to participate in the repayment program, and this can leave you with some debts to pay outside the payment plan.

Debt management programs cannot include all types of debts. A DMP can be good for consolidating small credit card accounts, unsecured loans, and bill payments, however, if you need help repaying student debt, tax debt or secured debts like a car loan you will need to qualify for a large enough debt consolidation loan to deal with these larger debts.

Compare the risks of taking out a debt consolidation loan

A debt consolidation loan requires you to qualify for new credit. You are applying for a new loan to pay off existing debts, leaving you with one monthly payment to your new lender.

A debt consolidation loan will allow you to combine any type of credit if you can borrow enough to cover your current debts. There are, however, reasons why you may not want to consolidate student loans in Canada.

There are risks with unsecured debt consolidation loans compared to working with a credit counsellor to repay debts:

• You may not qualify for a low-interest loan, and bad credit loans can charge as high as 59%
• You risk losing your home or car if you use these assets to secure your consolidation loan
• You could be in debt longer if your monthly payments are too low
• You risk staying in debt if you build up balances on your credit cards again

What is the effect on your credit score?

Your credit score affects your ability to get new credit. If you are already having difficulty paying down debt, the best program for you is the one that improves your creditworthiness the fastest down the road once you get out of debt.

There are several credit score factors to consider with each alternative:

• A debt management plan will be reported on your credit report as a repayment program. This notice will remain as part of your credit history for a maximum of six years and can affect your ability to get new credit during this period.
• In contrast, a debt consolidation loan will appear as a new trade account on your credit report. As long as you don’t drive up your old credit card balances again, a debt consolidation loan can lower your credit utilization rate, which may help improve your credit score.
• Depending on the type of loan you use, a debt consolidation loan can also help improve your credit mix by converting revolving debt, like credit card debt, into an installment loan.
• Both programs can help bring past-due accounts current if you can afford the payment.

Debt consolidation vs debt management vs debt relief

There is a risk with both a debt management plan and a debt consolidation loan that you have too much debt for either approach to work.

With both alternatives, you must be able to afford to repay your debts in full plus any additional fees or interest. If you can’t afford to keep up with the payment terms under either option, then you risk further default, more hits to your credit score, and worst of all, you will be in debt longer.

An alternative may be to consider a consumer proposal. A consumer proposal can consolidate debt and provide debt relief. A consumer proposal is an interest-free debt settlement option that can improve your cash flow sufficiently to allow you to get out of debt sooner.

A consumer proposal has the same benefits of a debt management plan, yet your monthly payment is much lower. A consumer proposal has no worse an impact on your credit score, in fact, I would argue it is better because you pay less, allowing you to save more and rebuild your finances much fast.

A consumer proposal is not for everyone. You may be able to get a consolidation loan with a lower interest rate than your paying on your high-interest credit card debt today and save enough money to pay of your debts. You may benefit from working with a credit counsellor to deal with a few small outstanding accounts if you don’t have a good enough credit score to qualify for a new loan.

However, if you have a lot of debt, and neither option seems affordable, a Licensed Insolvency Trustee is the only debt professional accredited to explain the pros and cons of all debt consolidation options, including a debt management plan, debt consolidation loan and a consumer proposal. Contact a Licensed Insolvency Trustee for a free, no-obligation consultation.

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Why you may need a cosigner for a debt consolidation loan

A debt consolidation loan rolls multiple high-interest debts into one new loan. Your potential consolidation lender is deciding the risk they are willing to take in allowing you to pay down debt you owe someone else, with new money they lend to you.

Lenders will look to three factors to determine your creditworthiness – your credit score, your income or ability to afford payments, and your current debt load.

Insufficient credit score

Your consolidation lender wants to loan you money, but they also expect to be paid back. They want to loan to someone with a proven track record of borrowing and repaying loans. If you have bad credit your lender may decide that there is too high a risk you will default on the loan in the future.

Lack of income

You may not have sufficient income to support the required monthly debt payments, especially if you don’t qualify for a loan at a lower rate. Lenders are also reluctant to loan money if you are self-employed, earn commissions or work under contract, all of which can mean your income is not stable enough to support the loan payments.

Too much debt

Even though you are applying to consolidate debt to help with your debt management, if the lender decides the total amount of debt you carry is too high, they may deny your application for more money. After all, you are not reducing your debts through a consolidation loan; you are just shifting money from one lender to another.

To reduce their lending risk, and ensure payment, your consolidation lender may ask you to get a cosigner. The lender wants someone with better credit to cosign or guarantee payment in the event you fail to pay back the loan.

How a cosigner can improve your loan application

A cosigner improves the quality of your application by providing the credit history you lack.

By providing an additional income source of income, a cosigner shows they can repay the loan if necessary. Your lender will look at your cosigner’s debt-to-income ratio to see that they have the capacity to make payments if you don’t.

As a guarantor of your loan, your cosigner will also need to have a good credit score and must have a proven track record of repaying debts because they feel you don’t. 

Your co-borrower must also have some available credit capacity – meaning they can’t carry a lot of excess debt themselves.

There are many benefits to getting someone to cosign a loan. Getting a cosigner can help you:

• Lower the interest rate you will be charged on your loan,
• Reduce the amount of down payment or security deposit you will need to make,
• Provide potential assets to secure the loan, and of course
• Increase the chances of your application being approved.

Responsibilities of a loan cosigner

Your cosigner is responsible to repay the debt if you don’t. If you default on payments, your lender will contact your cosigner and demand payment. Depending on the terms of the loan agreement, they may ask your cosigner to continue to make monthly payments or may demand payments of the loan in full all at once. They will also be responsible for the same late fees and interest penalties you would be under the original terms of the loan.

Your cosigner may receive calls from the lender or a collection agency.

Because your cosigner steps into your shoes, cosigning a loan can affect their credit score. As a co-borrower, they have applied for the loan with you, promising repayment. Your consolidation lender may report the loan on their credit report as well. Because they now have a higher credit utilization, this will affect their ability to borrow in the future until your consolidation loan is paid off.

You must have the consent of the lender to release a cosigner from any obligation for a cosigned debt. Often this requires the primary borrower to refinance after they have improved their credit score sufficiently to qualify for a new loan on their own.

Should you get a debt consolidation loan without a cosigner?

The most common types of cosigned loans we see are private student loans, car loans, and low credit consolidation loans.  All these loans can lead to substantial repayment risk for both the borrower and cosigner.

Asking a friend or family member to help you get a loan may sound like an easy solution to your debt problems, but it can harm your relationship if things go wrong. Your cosigner is still liable if you file bankruptcy.

I have met with people who have had to file a bankruptcy or proposal because they cosigned a loan. It is not unusual for us to file insolvency for both the borrower and co-borrower.

No matter what, you want to avoid making common debt consolidation mistakes.

Going it alone can also mean taking on a high-interest consolidation loan. Non-traditional lenders are usually more than willing to provide you with an installment loan or $15,000 line of credit at rates of 39% to 49%.  A high-interest consolidation loan may seem like a good idea when they tell you the monthly payment is less than you are making today, but in the long run, it’s generally a bad way to consolidate problem debt.

Consider a consumer proposal as an alternative

Rather than getting a cosigner, you could reduce the amount you are borrowing, wait to improve your credit, or if you can offer some collateral of your own. However, I know this isn’t always feasible for someone with a lot of debt.

If your consolidation lender thinks you can’t afford to pay back your debts on your own, they may be right. If that’s the case, you may qualify for a consumer proposal.

With a consumer proposal, you make an offer to your current creditors to repay what you can afford. You still get to make one lower monthly payment, but you are not risking anyone else’s finances. Sometimes a debt settlement approach is better than getting a new debt consolidation loan.

There are many ways of consolidating your debt without causing more financial hardship. Talking with a Licensed Insolvency Trustee is one way to explore your consolidation options.

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Before you jump in and start talking with a lender, it’s a good idea to understand how debt consolidation loans work, so you know how to structure your consolidation loan to make sure you benefit financially. The problem is there’s just too much noise out there around this subject to be sure. So we thought we’d cut through some of the chatter for you and unpack it all for reference.

What you need to know about debt consolidation loans

In this guide to debt consolidation loans, we answer these common questions:

• What can I consolidate with a consolidation loan?
• What are the advantages of consolidating with a new loan?
• How are debt consolidation loan interest rates determined?
• What are the eligibility requirements of most loans?
• What are the steps to apply for a debt consolidation loan?
• What kinds of debt consolidation loans are best?
• Are consolidation loans good or bad for my credit score?
• What are my other debt consolidation options?

What is a debt consolidation loan & what can I consolidate?

A debt consolidation loan is a new loan that you use to pay off and refinance existing debts. You get money from a new lender to pay off old accounts and then make a single monthly payment to pay off that new debt.

Almost any kind of unsecured credit can be rolled into a consolidation loan including:

• Credit card debt
• Unsecured lines of credit
• High-cost finance company loans
• Outstanding bills
• Overdrafts
• Payday loans
• Income tax debts

If your accounts have been referred to a collection agency, you may have more difficulty getting approved for new credit. Be prepared to pay a much higher interest rate if you do qualify.

Secured loans and term loans, like a car loan, cannot be consolidated into a new loan unless the original lender agrees. The reason being is that you signed a loan agreement with the original lender for a specified term and interest rate, and they have registered security on the asset you financed. They may agree to let you out if you pay a penalty.

Student debt consolidation is rare in Canada. It is possible to consolidate private student loans like a student line of credit or credit card; however the costs of consolidating government-guaranteed student loans generally outweigh the benefits.

Why get a consolidation loan? And what to watch out for.

There are advantages to taking out a consolidation loan:

1. You can reduce your monthly loan payment which can help balance your budget
2. You convert multiple loan payments into one, simple monthly payment
3. You can pay off debts sooner.

But these benefits are not guaranteed.  Two common mistakes people make with debt consolidation loans are getting an expensive high-cost loan and lowering their payment by extending the term too far.

Beware high-cost financing loans

A consolidation loan can save you money if you can qualify for a low-interest rate loan. Consolidating credit card debt with an annual interest rate of 29% into a new loan that charges 7% or even 15% can provide a substantial financial benefit. However, consolidating outstanding bills and credit cards into a 49% loan through a low-credit financing company is not a good idea even if it does lower your monthly payment. Companies like Easy Financial and Fairstone may be willing to approve you for a bad credit debt consolidation loan, but getting such a high-cost loan will not necessarily solve your debt problems.

Avoid longer-term loans

Even low rate consolidation loans can only pay off debt faster if you keep your monthly payment high. The higher your monthly payment, the more you put towards principal or debt reduction each month. This has a snowball effect – the faster you pay off your balances, the less you pay in interest, allowing more to be applied to the balance owing next month. This helps you get out of debt sooner.

Let’s look at an example.

Owen consolidates 5 credit cards into a new $20,000 debt consolidation loan at 9%.  Arda does the same. Owen chooses to set his payment at $636 a month. Arda lowers her payment to $415 a month. Owen will pay off his consolidation loan in just three years. Arda will not be able to pay off her debts for five years and will pay more than $2,000 in extra interest as a trade-off for lowering her monthly payment.

The key takeaway is to remember that whether you save any money and get out of debt sooner with a debt consolidation loan depends entirely on the terms and conditions of your loan agreement.

Read More: Should I Get a Debt Consolidation Loan: FAQ Video

How are debt consolidation loan interest rates determined?

Credit score and collateral are the two primary factors in establishing an interest rate on a debt consolidation loan. The higher your credit score, the lower your interest rate will be. Those with an average credit score may qualify for a loan at between 10% and 15%.  If you have a low credit score, a history of payment delinquencies, or other negative marks on your credit report, you may be charged a rate of up to 40%.

In general, traditional lenders like banks and credit unions will provide lower rate loans. Private lenders and financing companies will cost more.

Secured versus unsecured consolidation loans

The interest rate will also be lower if you can provide collateral to secure the loan. Secured loans, like a Home Equity Line of Credit or second mortgage, are lower risk for the lender than unsecured loans. Of course, just having security does not mean your rate will be low. Other factors, like your income and credit score, will still affect your consolidation loan interest rate.

Fixed-Rate versus Variable-Rate Loans

Interest rates can be fixed over the term of the loan or can be variable, meaning your rate can change at any time, as can your monthly payment. In most cases, a variable rate loan will be lower than a fixed-rate loan. This is because you are assuming the risk of future rate changes rather than your loan provider.

Additional fees

In addition to a monthly interest rate, your lender may charge you a processing, application fee or balance transfer fee. Most traditional banks do not charge loan fees; however, there may be costs associated with getting a mortgage appraisal or registering the collateral against your loan.

What types of debt consolidation loans should I consider?

The type of loan you can get will affect the cost, so choose carefully. You may also not qualify for every option, depending again on your credit score and if you have any security to offer.

Here are 9 common types of consolidation loans available in Canada.

The first loans are secured consolidation loans, while the latter are unsecured loans.  The loans are ranked based on the interest rate commonly charged, from lowest to highest, although there will be some variability based on your situation. Generally, the best interest rate on a debt consolidation loan will be on a secured debt consolidation loan, such as a mortgage, and the highest interest rate applies on a high-risk unsecured loan.

Mortgage Refinancing

If you own a home and have equity built up, you can use that equity to pay down your credit card debt by refinancing your existing mortgage. The best time to do this is when your mortgage comes up for renewal. If you try to change a mortgage mid-term, a penalty will apply, which will lower the savings you can achieve by consolidating.

Second Mortgage

Another way to use your home equity, is to take out a second home equity loan or second mortgage. Most traditional lenders will only lend up to 80% of the value of your home. There are secondary and private mortgage lenders who may loan up to 95% of your home’s appraised value; however these are high-risk loans and come with a high-interest rate. We generally recommend against borrowing against your home equity above 80% without first considering an interest-free consumer proposal.

Home Equity Line of Credit

A home equity line of credit or HELOC is a line of credit rather than a term or fixed loan. HELOCs provide a lot of flexibility in how you use your home equity.  You receive an approved credit limit and draw only the amount of money you need. Payments are often interest-only, which can be attractive for your budget. However, the downside is you are not paying down your debt balances. If you use a HELOC to consolidate debt, be sure to create a formal repayment plan to get out of debt.

Secured consolidation loan

It is possible to secure a consolidation loan with almost any asset you own, not just your home equity. You can use savings, investments, stocks, and bonds as collateral. It is not possible to borrow against your RRSP in Canada except for the specific purpose of buying a new home or financing your education.

Vehicle loans

Another option is to borrow against your car if you own the vehicle outright or have equity built up from paying down your car loan. Often called car title loans or auto equity loans, some lenders specialize in allowing you to borrow against the value of your car. Beware, these can be one of the most expensive forms of secured consolidation loans and can create a rollover trap of car loan debt.

Unsecured line of credit (LOC)

If you have good credit, you may qualify for an unsecured line of credit to pay off your credit card debt. While you have flexibility in terms of your payments with a LOC, it is always better to make more than your minimum payment, because you want the debt to go away. Also, know that the interest rate can change as the prime rate changes. If the prime rate goes up, your minimum payments will increase. A line of credit can be a trap if you don’t have a handle on your finances.

Unsecured debt consolidation loan

An unsecured loan has no security, which makes this a riskier loan for a lender. That means that to qualify for an unsecured consolidation loan, you will need a good credit history and credit score, positive net worth, and a good income. Unlike an unsecured line of credit, this is a term loan with a fixed monthly payment and defined payback period.

Use Credit Cards to Consolidate Debt

You may be able to take advantage of a low-interest credit card or promotional offer to consolidate debts. You can accomplish this through a balance transfer from high rate cards to low rate credit cards. The downside of this approach is that promotional rates may only be temporary and again, you need to make more than the minimum payment if you want to eliminate your debt.

Payday loan consolidation

Payday lenders today offer more than the typical two-week payday loan. Many promote larger loans and lines of credit, often up to $35,000, money which can be used to consolidate other debts, including payday loans. These loans, like those from other financing companies, often bear an interest rate of at least 39%-49%. 

How do I qualify for a debt consolidation loan?

Lenders will apply a variety of criteria to decide whether you can be approved for a debt consolidation loan. Your ability to pay back the loan will be a top concern.

Factors that affect your eligibility for a debt consolidation loan include:

• Your credit score and credit history
• Your assets and net worth
• Your employment history
• The stability of your income
• Your debt to income ratio

What’s a good debt-to-income ratio?

Your debt-to-income ratio is calculated as the total monthly debt payments (including your mortgage or rent) divided by your total monthly gross income.

Ideally, your debt-to-income ratio should be less than 36%. Most lenders will not extend credit if your debt-to-income ratio is above 43%.

You can confirm your ratio with our debt-to-income ratio calculator.

What credit score do I need?

Traditional lenders generally require a minimum score of 650 or more. At the low end of that range, you will still pay a premium rate, and you should still compare the cost of your loan with that of a debt management program or consumer proposal. If your score is above 700, or good, you will likely qualify for a low-rate loan.

A score between 550 and 650 may qualify you for a debt consolidation loan from a second-tier lender but expect to pay very high-interest rates. If your score is below average, consider looking at alternatives like a debt management plan or consumer proposal.

If you have very bad credit, generally 550 and under, you will not qualify for a debt consolidation loan and will need to explore other debt consolidation programs like a debt management plan or consumer proposal.

Should I get a co-signer?

If you are unable to qualify on your own, you can ask a friend or family member to co-sign your consolidation loan. A co-signer is someone with good credit who guarantees your loan. This means, however, that if you don’t pay, the co-signer is on the hook.  If there is a risk that you will lose your job, or otherwise be unable to repay your consolidation loan, it may not be worth risking a friendship or putting your parents’ financial future at risk as well.

Should I get a joint consolidation loan with my spouse?

If you are married and your spouse has a better credit rating than you, you may qualify for a lower interest joint consolidation loan to consolidate your debt. But, beware, consolidating debt with your spouse does not solve your debt problem. You are simply extending the joint legal obligation to your partner. Your spouse would then also be 100% liable for the debt and the consolidation may affect their credit score negatively.

What are the steps to get a debt consolidation loan?

When you apply for a debt consolidation loan, you will be asked for information about your income, expenses, current debt payments, credit history, how long you have lived at your current address, and more. 

Hard hit versus soft hit

Before you apply, it is important to know that hard inquiries affect your credit score. A hard inquiry happens when you apply for a loan. Every hard inquiry or ‘hit’ is recorded on your credit report. Soft inquiries do not affect your score, including checking on your own score. Be sure to understand what your lender is pulling if they tell you they will run a pre-approval or preliminary qualification.  Ask if it will be a hard hit or soft hit. Only apply for a debt consolidation loan if you feel, based on the process we describe below, you have a high chance of being approved.  If you are uncertain, consider postponing your application until your situation improves or review your other debt relief alternatives.

Here are the 10 steps involved in applying for a debt consolidation loan:

1. List all your debts. Before you apply, make a list of all your creditors, their outstanding balances, interest rates, and monthly payments. Include both secured and unsecured debts regardless of whether you plan to consolidate all of them or some of them.
2. Devise a realistic income and expense budget. This step is essential in determining how much you can afford to pay every month. Potential lenders will want to know that you can make payments on a debt consolidation loan, so remember to include documents that can confirm your income, such as recent pay stubs and your most recent tax return.
3. Calculate your debt-to-income ratio. If your ratio is over 43%, then a conventional debt consolidation loan is most likely going to be out of reach.
4. Know your credit rating. Lenders will certainly be interested in your credit rating, so you should know this, as well. There are two credit reporting agencies (Equifax and TransUnion) in Canada, and you can get a free credit report from each of them annually.
5. Apply but not too often. Once you have researched the type of debt consolidation loans with the best interest rates available to you, contact potential lenders, and apply for a loan. If you are turned down, ask why so you can address the issue like improving your credit score. Avoid repeat or multiple applications, as this will lower your score even more.
6. Complete the application. Once you have provided all the necessary documents, such as tax returns, proof of collateral, and a list of your current debts, lenders will evaluate whether they can risk offering you a debt consolidation loan and at what interest rate.
7. Compare interest rates for savings. Calculate the current weighted average interest rate of the debts you plan to consolidate. We have a free debt repayment worksheet that can help you do this. Compare this number to the interest rate offered by your debt consolidation loan lender to ensure you are saving money.
8. Know the details of any offers you might receive. Don’t sign an agreement until you thoroughly understand the terms of the loan. If you are unsure about any details, ask questions, and get clarification in writing.
9. Make the payments. Once you sign a loan agreement, you are legally bound to adhere to the terms. Make the payments you agreed to in writing.
10. Continue to check your credit and debts. You or the lender should pay off your creditors as agreed, but there could be errors or discrepancies with payouts. Be sure to contact all the parties involved to resolve such issues as quickly as possible. Also, follow up again in a few months to ensure that all credit card balances and other included debts are at zero as they should be. Get a copy of your credit report and monitor what activity appears going forward at least twice a year.

How does a debt consolidation loan affect my credit score?

A consolidation loan can have both a negative and positive effect on your credit score going forward, depending on the choice of loan and how you manage your accounts after consolidation.

How will a consolidation loan improve your credit score?

Three factors that positively impact your credit score when you consolidate debt through a consolidation loan are a lower credit utilization, better loan diversity, and improved payment history.

By converting maxed-out credit cards into a consolidation loan, your utilization rate will improve as you make payments. You will also show less reliance on revolving consumer credit.

As you make your consolidation loan payments, you build a new and better payment history and continue to reduce your credit utilization, which improves your credit score over time.

Can a consolidation loan hurt your credit score?

Many are surprised to learn that their credit score often temporarily declines immediately after applying or being approved for a debt consolidation loan. There are several reasons why this happens:

• As mentioned, any new credit application is a hard inquiry and will lower your credit scores by a few points.
• Similarly, having a new credit account shows an increased need for credit and will hurt your credit score in the short term.
• Length of credit history is also a credit score factor. By having a brand-new loan, you lower your average age of credit.
• Your lender may require that you close credit accounts you have with stores or credit card issuers. Closing accounts can temporarily lower your score by reducing your available credit and thus increasing your utilization rate.

Getting a consolidation loan can permanently lower your credit score if you continue to use your old credit cards. Racking up further debts will harm your credit score.  In addition, if you default on your consolidation loan payments, your credit score will get worse.

What are my other debt consolidation options?

While a debt consolidation loan is an excellent strategy to convert multiple high-interest credit card payments into one lower monthly payment, it is certainly not the only debt consolidation option for those looking to manage debt. Consider these alternatives to a debt consolidation loan.

Debt consolidation program with a credit counsellor

A debt consolidation plan, also called a debt management plan, is good if you can afford to repay 100% of your balances owing plus their 10% fee over 5 years.

Consumer proposal with a Licensed Insolvency Trustee

If you have too much debt to repay, you can make a consumer proposal to settle your debt for less than the full amount owing through a Licensed Insolvency Trustee. A consumer proposal is a good option if you have some equity in your home but not enough to deal with all your debts or you will risk your home with a high-ratio mortgage above 80%.

If a debt consolidation loan will reduce your monthly payments, lower your interest rate, and allow you to get out of debt faster, a debt consolidation loan is probably a good idea. On the other hand, if you don’t qualify for an attractive interest rate or you are not sure you can afford the monthly payments, contact a Licensed Insolvency Trustee to talk about these other options.

The post How Does a Debt Consolidation Loan Work? appeared first on Hoyes, Michalos & Associates Inc..

But what you probably don’t know is that your bank can change the borrowing terms on your HELOC whenever they want. I talk with Scott Terrio and he shares why you need to think twice before signing up for a home equity line of credit. 

How a Home Equity Line of Credit Works

Home equity is the difference between the value of your home and the unpaid balance on your mortgage. Your home equity goes up two ways: by paying down your principal balance; and if the value of your home increases. 

Here’s how a line of credit works:

• In Canada, you can access up to 65% of the value of your home through a home equity line of credit.
• Payment of a home equity line of credit is secured by your home just like your mortgage. So, if your mortgage is $200,000 and you borrow $70,000 via a HELOC, your total secured debt becomes $270,000.
• Before you can borrow a HELOC, your bank will run a stress to see if you qualify. 
• Once you qualify, you can use as much or as little of the HELOC as you wish.
• There is a monthly cost once you draw funds from your LOC.
• You usually are required to make interest-only payments on your outstanding balance.
• Interest is calculated daily. HELOC interest rates are set as Prime plus a number. 

The Risks of Borrowing

You should know that a home equity line of credit is a “callable” debt, which means there is no limit to how the bank can change the borrowing conditions of your line of credit.

One of the biggest risks of consolidation loans, especially variable rate loans, is a rise in interest rates. Your bank can change the rate charged on your HELOC at any time.

Another common example is requiring you to begin making principal repayments. Your original terms may have required that you make interest-only payments on your HELOC. But, if your financial situation changes and the bank deems you to now be a credit risk, you may be asked to pay a portion of your outstanding loan balance, in addition to interest. This new repayment expectation can be a shock to your finances if you’re not ready.

Most importantly, when you borrow against your home, you’re increasing your secured debt obligation. This can be an issue because failure to repay a secured debt means losing the asset that secures it. In this case, the asset is your home.

Ask Yourself 5 Questions Before Borrowing a Home Equity Line of Credit

Before taking out a HELOC, consider the following scenarios that could make financial management more difficult: 

1. What if you have to relocate for a job or due to divorce? Could you sell your home for enough money that you would recover your mortgage principal plus HELOC and selling fees? You don’t want to be stuck paying a negative balance.
2. Could you still afford HELOC payments if you lost your job? 
3. What if your home value decreased? It’s not uncommon for Canadians to owe more on their homes than their properties are worth when the real estate market falls. This concept is called being ‘underwater’ on your mortgage. While being underwater and effectively having zero equity doesn’t have to be a problem, your ability to refinance any unsecured debt you accumulate would be limited.
4. Could you afford an interest rate increase? As mentioned, your bank can change the cost of servicing your HELOC at any time. Could you afford to pay more towards your debt than you already do?
5. Do you already have unsecured debt? If you already have credit card debt it may not wise to add to your debt by borrowing more through a HELOC. It’s in your best interest to pay down your other debts first before taking on new debt, even if the interest rate is low. 

Using a HELOC to Refinance Your Existing Unsecured Debt

A common method of paying off high interest unsecured debt like credit cards is by refinancing with a HELOC. There is nothing wrong with this strategy as long as it deals with all of your unsecured debt and you avoid accumulating unsecured debt again. A mistake borrowers sometimes make is refinancing when they don’t have to. It’s better to speak to a Licensed Insolvency Trustee about all your debt elimination options to see if there is a cheaper alternative available to a HELOC. And if you do opt to refinance, you should cut up your credit cards to avoid any temptation to build up the balances again. 

Read More: Debt Consolidation

Eliminating the Sales Pressure 

Your bank will try and make a HELOC sound great, after all the bank makes money when you borrow. A HELOC also has limited risk for the bank. If you are unable to repay your HELOC, they have security against your biggest asset – your home. But at the end of the day, no matter how affordable a loan is, it’s still debt.

To eliminate the sales pressure, Scott suggests some tactics to decline a HELOC offer more easily:

• Tell your lender you want to go home and think about it.
• Say the full HELOC number out loud. Are you being offered $70,000? Saying that number out loud reveals just how big of a number it is, which can make declining more easy.
• Think about your entire financial picture. Do you really need a HELOC right now and can you repay it down the road?

For more details on how a HELOC works and the risks to borrowing, tune in to today’s podcast or read the complete transcription below. 

Additional Resources

• Straight Talk on Your Money Book
• Scott Terrio Twitter
• Debt Free in 30 YouTube Channel

FULL TRANSCRIPT – Show 231 Think Twice Before Getting a Home Equity Line of Credit

Doug:                When I have Ted Michalos on this podcast, if I want to get him all fired up I mention the type of debt that is his pet peeve, payday loans.

                             Well today I’ve got Scott Terrio on the podcast so I’ll pull the same stunt with him and mention his debt pet peeve. Yeah, you guessed it, HELOCs.

                             So let’s see how good a job I can do getting Scott all wound up. Scott is the manager of consumer insolvency here at Hoyes, Michalos and he is frequently quoted in the media, often about HELOCs. So Scott, welcome back to Debt Free in 30. Ready to talk HELOCs?

Scott:                   Thank you, Doug, I am, yes.

Doug:                   Well so let’s start with the obvious question then. What is a HELOC?

Scott:                   Right. Great question. A HELOC is a home equity line of credit, and a lot of people have them.

Doug:                   Okay. So what does that mean then? What are the attributes of a home – I mean a line of credit, I know what that is. I got to the bank and they give me money and I can borrow whenever I want. What’s the difference with that-

Scott:                   So a home equity line of credit, think about the term, it’s home equity, so you’re using – you’re borrowing against the equity in your home. So you’ve got room between your mortgage and the value of your house, so you’ve got equity. The bank’s happy to lend you based on that. So it’s secured to your house, or it’s secured by the physical asset that is your home. So if you don’t pay, just like with your mortgage that’s the asset that’s under scrutiny by the bank. There’s no amortization period with HELOCs so it’s just here you go and unlike your mortgage which is laid out for you for the next, you know, 25 years sort of in terms of how much it’s going to be paid down and the payments and all that stuff, there’s none of that with a HELOC.

                             Also –

Doug:                   And that’s what you mean by no amortization period. So a typical mortgage there’s a 25-year amortization period –

Scott:                   Where it’s paid off.

Doug:                   So I know that in 25 years if I make all my payments it’s done.

Scott:                   Right.

Doug:                   Whereas with a HELOCs, so what am I paying in a HELOC then?

Scott:                   Interest only, mostly.

Doug:                   Interest only, okay.

Scott:                   And I think the latest figure in Canada is 25 or 30 percent of HELOC borrowers are paying interest only.

Doug:                   So I borrow $10,000, the interest is X number of dollars this month, I pay that, I still owe $10,000.

Scott:                   The principle’s going nowhere.

Doug:                   And I could be paying my interest for years and years and years and still owe the same amount.

Scott:                   Right and I think the average borrowed amount of a HELOC in Canada is $68 or $70,000 and the average approved is about $168 or $170,000.

Doug:                   Wow.

Scott:                   So there’s an awful lot of runway as they say.

Doug:                   So that all sounds fantastic then.

Scott:                   It does. It sounds great.

Doug:                   Yeah, it’s secured by my house, so the person who’s lending me the money, the bank, has very little risk because unless the real estate market totally collapses they can always get paid. So the interest rate is typically very low. Way lower than a credit card interest rate. And I’m getting – I’m paying a lower interest rate. So the bank has no risk, I’m paying a low interest rate, this is fantastic. I guess the show’s over, this is the greatest thing ever and I cannot envision any possible downside to this scenario.

Scott:                   No possibly, and I think that’s probably exactly the sales speech that people get, pretty much, Doug, is this is great. And that’s – the way you said it is probably exactly why there are so many HELOCs out on the Canadian marketplace.

Doug:                   Well can you think of any possible downside to this fairy tale that I just told?

Scott:                   I can think of a few.

                             Number one is they float with the interest rate. So as you know, interest rates have gone up five times in the last couple of years. They could be going up again. There are some reports saying no, but you have to, probably, if you’re a prudent borrower you would have to expect that they would, because on a balance of $70,000 that’s not insignificant for a rate hike. Or especially multiple rate hikes. So if you have three, four, five rate hikes on 70,000 or more, that’s going to be a significant hit to your pocket on your interest payments.

Doug:                   Yeah, if interest rates go up by a quarter a point and I’ve got to pay an extra 20 bucks, well who cares?

Scott:                   Right.

Doug:                   But if that happens, as you say it’s happened five times and we’re recording this at the end of January 2019, so if you’re watching this in the future, you know, internet world, then perhaps they’ve gone up more than that, but five times 20 bucks in my example, that’s a hundred bucks. Again, it doesn’t seem like a big number, but that’s a hundred bucks every month, now you’re paying 1200 bucks extra a year, all your other debts have also gone up and become significant.

Scott:                   And the other factor in that, as we know from our business, is that home owners tend to have a lot more unsecured debt than renters. About 20, 30,000 more. So if you have a home equity line of credit that’s gone up a hundred bucks in those five rises, you probably also have two or three other lines of credit that are unsecured, those are also going up.

Doug:                   Yeah, and that’s a very key point.

Scott:                   So when you throw it all together – so here’s your hundred for the HELOC, probably another hundred for the other three or four lines of credit. Now it’s 200. And I think there are studies showing –

Doug:                   Yes there are.

Scott:                   – that, you know, and I’m not sure exactly their statistical validity, but a lot of Canadians are close to the edge every month. So 200 bucks, to me that’s significant as a monthly expense that you didn’t expect to have.

Doug:                   And your point is a very valid one because we notice this when we do our Hoyes, Michalos Joe Debtor bankruptcy study that you’re right. Somebody who owns a house and has a mortgage also has more unsecured debt. They’ve got more credit card debt, and that’s partly because they’re a better risk to the bank. You own a house so you’re not going anywhere.

Scott:                   It makes sense.

Doug:                   So you end up having more of that higher interest rate debt too.

                             Okay, so downsides to HELOCs. Number one, they can increase the interest rates any time because your typical HELOC is a floating rate, so anytime the Bank of Canada raises rates there’s a very good chance that your rate is going up.

                             What are the other problems then? What are the other risks I should worry about?

Scott:                   So the other risks involved with HELOCs is there really are no – there are no limits to what the bank can do in terms of changing the rules. They can call them. It’s a fully callable loan. Now, is that going to happen in a wide-spread housing market scenario? Probably not. But I think the point is you wouldn’t want that in your mortgage. I mean anybody sane would at least know –

Doug:                   A little risky.

Scott:                   – they know whether their mortgage is fixed or variable. Okay, that’s great. That’s about all I can handle in my head. But what if there were no other rules on your mortgage? Okay, so here’s 700,000 Mr. Hoyes. Pay it over 25 years, but we might just change this along the way at any point and you can’t do anything about that.

Doug:                   And so what kind of rules could get changed then? I mean the interest rate is the most obvious one, but you’re right, they could decide that we don’t want you to have this HELOC anymore. And we’ve seen that a lot with unsecured lines of credit.

Scott:                   Yes.

Doug:                   Which are not HELOCs. They’re not secured by your house. I mean you and I can both tell lots of stories about that client who was paying 5 percent a year ago and now it’s 10 percent.

Scott:                   Right.

Doug:                   It’s not because the interest rates have gone up, it’s because the bank has said, oh, you look like a higher risk than you used to be. We’d like to squeeze you a bit. Maybe you’ll jump off and go somewhere else.

Scott:                   I think that’s the hidden monster in this, is the credit cycle is turning so we had a good run for – you know, we had emergency interest rates for almost a decade, because they just left them low. So everybody got used to having almost virtually zero percent interest on everything. And we went on a debt binge as consumers.

                             So now – you and I see this more as frontline people, so I think it maybe is more apparent to the work that we do. For at least a year or so now the banks have been behaving differently in terms of how they vote on proposals, which is a really good canary in a coal mine for us to see, okay, well the big five banks and the next secondary level of lenders have all done whatever they want over the years in terms of voting on proposals. So some of them are hard asses, so of them are easy to deal with in proposals. And we’ve seen in the last 12 to 18 months, especially the last six, that’s starting to change.

                             So the banks are getting – they’re getting more nervous. This is normal in this type of a cycle.

Doug:                   So change in what way?

Scott:                   Like voting down proposals. Counter offering really hard counter offers. You know, someone who’s offering their creditors a percentage settlement that we got accustomed to seeing as being accepted, now the banks are going, you know, we’d like a little more than that. So then of course we go, okay, and if that happens for a number of months it’s a trend. So that is happening.

                             And so when you think about HELOCs and the fact that the banks can kind of pull whatever levers they want, I don’t think they’re going to, as I said, go call them all. That would be suicide. But I think what they’ll do is they’ll make little tweaks along the way that hurt you a little bit. It’s like your term, death by a thousand cuts. And so if you’re exposed in that manner as a consumer, well do you want to be at the whim of a bank that’s nervous?

Doug:                   Well, so your HELOC might be set up that you’re paying interest only. There’s no reason the bank can’t say, oh, you know what? We’ve changed the terms. Now you have to pay 1 percent of the balance each month plus interest. Like, they can do that any time they want.

Scott:                   They can do anything they want. So you could almost come up with almost anything that a bank could tweak if they’re getting nervous.

                             So they’re probably going to go after a certain type of lender first, because they’ve got their categories, their borrower. This type of borrower, that’s really bad. The other ones we’re going to leave them alone for a while.

Doug:                   Well and most banks, and again maybe people don’t realize this, do a soft hit on all their customers. So every quarter, let’s say, and I know one bank in particular definitely does this because the VP told me. They will do a credit check. It’s a soft hit so it doesn’t show up. You don’t actually know it’s been done. It doesn’t affect your credit score or anything. But if they see that, oh, look at the trend. You’ve got a bunch of other debt. Your credit card balances are going up. We’re getting a little more nervous as you just said. So this is the perfect opportunity for us to say, you know what? Even though the Bank of Canada raised interest rates a quarter of a point, we’re going raise your HELOC interest rate half a point. Or a full point. They can do whatever they want.

                             Okay, so we’ve talked about the risks to me the borrower. But hey, look, why should we worry? It’s guaranteed by my house. That’s the whole point of a HELOC. Everything’s good. Don’t worry about it. Right?

Scott:                   And what if house prices drop?

Doug:                   It could never happen.

Scott:                   No, never happens.            

                             So if they did in the could never happen scenario, and you end up under water. So now your house – under water meaning your house is worth less than you owe on it. So for everybody that bought in 2017 in a certain area who were just right up to here in terms of loan value or whatever –

Doug:                   For those of you who aren’t watching on YouTube he did the sign where you’re right up to here, right up to my chin here. That was the chin sign.

Scott:                   Yeah, that was the radio –

Doug:                   Have to watch this on YouTube.

Scott:                   Those people, even if the market’s down 10 percent, and a lot of places it’s down more than that, you’re under water.

                             Now that doesn’t mean anything. Okay. It just – anything more than the fact that your house is worth less than you owe. You don’t have to leave. The bank isn’t going to come after you. You keep making your mortgage payments, everybody’s happy.

                             But it makes a number of people again nervous.

Doug:                   Well you can’t sell your house and get out even.

Scott:                   No. You can’t even pay the costs if you sell it –

Doug:                   And this whole word under water is a word we haven’t said for the last 10 years because house prices since around, I don’t know, 2009, 2010 have been increasing and we’re talking primarily about Ontario but I think anywhere in North America it’s pretty much the same thing.

Scott:                   I’d say so.

Doug:                   There may be some pockets, like Fort McMurray got hammered a few years ago. But in general house prices have been going up. So it didn’t really matter how much I borrowed. It didn’t matter if I borrowed 95 percent of the value of the house, next week the house would be worth more so I’d be building, building equity.

                             But since the market peaked around May of 2017, I guess, and has been falling ever since – and you’re right. In downtown Toronto, which is where we’re recording this right now at our office at Yonge and King, the condo market is still strong. I mean it’s still growing and the prices are still going up.

                             But you go to places like Oshawa, Richmond Hill, you know, west of Toronto, single family detached homes, there are some areas where we’re getting reports of prices dropping 20 percent. And so if you paid a million bucks and financed it right to the hilt, $950,000 in mortgages and your house is now worth 800, and you sell it and have to pay real estate commissions, you are, as you say, under water by potentially a couple of hundred thousand dollars.

                             Now if I have a mortgage that is, you know, 80 percent loan to value. Okay, if the price goes down 20 percent, I guess that puts me back to even. But HELOCs, as you explained it, are on top of a mortgage. And that’s where the huge risk potentially comes in then.

Scott:                   Right. I mean if you had a mortgage of 700 and your house was worth a million and you borrowed 100 with a HELOC, now you’ve got 800, so again, if it went down 20, now you’re flat again so if you went to sell your house you’d be underwater. Because being flat and selling your house with the costs of selling a house, now you’re underwater by that margin again, right?

Doug:                   So do you think we have a false sense of security because, well house prices, okay, maybe they go down a little bit, but it’ll all be good and if I don’t sell my house it doesn’t really matter and I shouldn’t worry about it?

Scott:                   I do. Because let’s put it in terms of unsecured debt. So if your bank, if you had $30,000 in unsecured debt, credit cards, line of credit, and your bank came to you and said, you know what? We’re having a banner year. How would you like another 70,000? But we won’t give it to you at a credit card rate of 18 percent. We’ll give it to you at five or something.

                             Would you take it? Sure, that’s a great deal. You probably wouldn’t touch it because it’s unsecured.

                             Where the HELOC risk comes in, I think, and this is kind of insipid – it’s your house so therefore it’s great. It’s safe, you’re going to live in it forever so if I borrow against it so what? I mean I’ve got my whole life to pay this off. And again, translating that balance, that average 70,000 into another type of debt, you probably wouldn’t – there’s no way.

                             First of all, the bank wouldn’t offer that. But in HELOC they’re happy to because it’s your house.

Doug:                   So your point is if I have 50,000 or 70,000 in credit card debt, I’m freaking out.

Scott:                   Yeah, or additional.

Doug:                   Or additional. But if I have a $70,000 HELOC, I’m not worried because the interest rate’s lower, but even so it’s guaranteed by my house so everything’s going to be fine.

Scott:                   Some of this is, like, the collective psyche of Canada. The house is the – that’s the ultimate goal in life is the house ownership thing. We’re still in that I think. I thought that mindset would break, but since housing prices went crazy –

Doug:                   Didn’t I talk about that in my book somewhere. I’m pretty sure I did here –

Scott:                   And how did that stack of books find its way there?

Doug:                   I don’t know how they managed to get in the camera shot here. That’s amazing. Somebody must have set it up – yeah, myth number 13. A house is a great investment. Myth number 14, owning a house gives you stability. Myth number 15, the bigger the mortgage the better.

                             So you’re right. Real estate is a big thing for us as Canadians, and I assume that’s why the banks love it. So according to my notes here, banks have lent out billions of dollars in HELOCs, something like $230 billion dollars. That’s a really big number.

                             Why is – but the interest rates are low. So why do the banks like them so much? I mean you think they would like credit cards more because the interest rates are higher.

Scott:                   Yeah, because of all the things that come with it, I think. So first of all, it’s secured, so for the banks, nice low risk. We can always take the house if we need to. We don’t want to be house owners but you know, if worst case scenario we take the house and we’re pretty much made whole.

                             But the other thing is, is that it gets you more locked into this debt trap or cycle. They’ve got you that much more. And as we’ve said, the average home owner that we see in insolvency has $30,000 more in unsecured debts. So all those trappings come with this.

                             And the other thing is, when banks lend, they want to lend profitably. Right?

Doug:                   Makes sense.

Scott:                   Back to the whole credit score system. They want you as a client because they’re going to make money off you. They don’t want to do a risk assessment on you so that you’re safe. They do a risk assessment on you so that you can make them tons of money over time.

Doug:                   So that they’re safe.

Scott:                   And so the other things with the ATMs is the ease of usage and this is probably my biggest pet peeve about them. It is so easy to tap them and it is so easy to use them because they just say, here you go, and they approved you for the 68,000 or whatever. You don’t have to keep going back to that. So the barrier, the psychic barrier of getting up, going to the bank, sitting there in a suit and begging for more money isn’t there. Right? You just – here you go, it’s basically a cash ATM.

                             And the banks really want that because you’re going to use that right?

Doug:                   Yeah, you’re right. To get a mortgage there’s a bunch of stuff I’ve got to do. I’ve got to apply, I’ve got to show my income, in most cases.

Scott:                   You’ve got to grovel a little bit.

Doug:                   Yeah, and you know, do you qualify? What’s the appraiser going to come in at, boy I’d better talk to the appraiser and make sure that he saw that I painted that wall over there and it’s worth more.

                             Once you qualify – and that’s it, there’s your mortgage and you’re paying it off for the next 25 years, whereas with a line of credit, once I’m approved it’s there. And you’re right, the bank says, hey why don’t you just take it? You don’t need to use it. Great. So I know it’s sitting there. Well inevitably if I’ve got a pot of $100,000 of available credit just sitting there –

Scott:                   And I’m cash flow tight, like many Canadians.

Doug:                   Everybody is. So it’s like, you know what? The car transmission broke down. Why don’t I just use it for that? Or why don’t we put in a deck, or a pool or something. And – my recollection is that’s really how we got started in all this, wasn’t it?

Scott:                   It was. The original intention of this, and this may be going way back before they were called HELOCs, but the idea was you use the equity in your home during good times to improve the home significantly enough – not painting the wall, but put like a pro kitchen in, or put, like you said, a deck, or something that is really going to have attractive curb appeal or interior appeal later on when you go to sell it. Because usually you can inflate the price much more than the renovation was if it’s all done nicely.

                             And then I think the banks got onto the – hey, this is pretty good. Do people are using this for whatever, do we care? Not really. I mean defaults are miniscule, like –

Doug:                   It’s all good.

Scott:                   They almost don’t exist. So you know what? Like anything else, banks see something good, they just start handing it out more and consumers who entered the era of low wage growth and things getting more expensive, especially in cities found themselves strapped. And you want to live the lifestyle right? So you know, you said, that hundred grand is sitting there. How temping is that? Right?

Doug:                   Well and if I have some money owing on my credit cards that are a high interest rate, it’s prudent financial management to say why don’t I take 20,000 off my HELOC, pay off my credit card. I’m exchanging a 20 percent interest rate for a five percent interest rate, that’s actually good sound financial management, isn’t it?

Scott:                   It’s great. Except you still owe the debt over time. And I think instead of paying that debt down, you’ve just shifted it. So yes, it’s lower interest, that’s – that is a good move, technically and mathematically.

                             But I think it shows that people are looking at their unsecured debt and going okay, instead of paying that down I’m going to pay it with this, but that’s not paying it down.

Doug:                   Particularly if it’s an interest only HELOC where you’re definitely not paying it down.

Scott:                   Exactly.

Doug:                   And as you already alluded to, that’s great but we know that homeowners tend to owe – well, they do, it’s a fact – they owe more on their unsecured debt because of that exact same thing. I’ll use my HELOC to pay off my credit cards, but then I use my credit cards again so now I’ve got actually more debt than I started with.

Scott:                   Yeah, and part of this is the whole normalization of debt. You know, debt is the new normal thing. It’s the whole thing of the debt zombie. We’re just a walking group of debt slaves and we don’t care if it’s on our credit card or if we shifted it over here. It doesn’t bother us much.

Doug:                   So why is it then that, you know, five times a week you and I talk to someone who says yeah, I did get preapproved for this, I didn’t ask for it, the bank just said, yeah, here you go, you’re a good guy, here it is. Is it as simple as, well this is how they make money? That’s why they do it?

Scott:                   Yeah. I think it might be.

                             Like when you are – when you’re faced with the bank offering you a HELOC of 70,000, probably what you should do is instead of just taking actually say, okay, I’m going to think about that. I mean I’ve counselled this before on HELOCs and in pieces I’ve written and on TV just saying, just stop, right? So take the pressure out of the situation. Take the sales pressure out, go home, think about it. I mean the bank’s going to make sure they call you again. They’re going to want to sell you stuff. It’s what they do now.

                             So stress test yourself, right? So if I’m going to get 70 grand and I’m going to – eventually I have to pay that off in some way, shape or form. So maybe make yourself a worst case scenario. If rates go up another five times, not likely to happen, maybe, but it could, right?

Doug:                   It very well could.

Scott:                   They’ve been really low for a very long time, and anybody older than 35 has seen this kind of thing happen before. So stress test yourself and make sure the worst case scenario comes up, you can make at least monthly payments if not contributions to your debt.

Doug:                   And when you talk about stress testing you’re talking about things like, well if I lost my job what would I be able to do?

Scott:                   Right, events.

Doug:                   I think there’s another element to that, and that is, what if you had to move? So let’s say you get a fantastic job offer in Alberta.

Scott:                   Can’t turn it down. Got to go.

Doug:                   It’s fantastic, way more. But I’ve got a house now that I bought, you know, at X dollars and it’s 20 percent less –

Scott:                   In the outer rim.

Doug:                   In the outer rim. And so I can’t sell it and get enough to pay off the mortgage and the HELOC. So what do I do? Do I sell it – what you’d have to do is go to the bank and say, okay, I’m going to sell my house and there’s going to be a $200,000 shortfall. I need you to give me a $200,000 loan so I can move.

                             Is the bank going to want to do that? That sounds pretty sketchy to me.

Scott:                   But these things happen.

Doug:                   They happen all the time.

Scott:                   That’s a real-life example right?

Doug:                   How many people do you know of your circle of friends who’ve been living in the same house for 20 years?

Scott:                   None. No, one. I’m sorry. And I’ve got a big circle of friends, and I can tell you one. And in my parents’ generation it would have been everybody.

Doug:                   Yeah. I mean the house I grew up in, my parents were there for, I don’t know, 20 years, 30 years, whatever it was. It was a long period of time. But now we’re much more mobile.

Scott:                   Absolutely. It’s a different world.

Doug:                   And we all want to buy the McMansion. So we start out with our little condo and then we get married and we buy the starter home and then we move up to the middle home and then we move – so whereas our parents kind of lived in the starter home their whole life. There was no need to do it.

                             So I think that’s the other element of the stress test is what are the chances I will have to move? Maybe I want to move. Maybe I just want to move on the other street so my kids are in a better school district. Owning a house, as I said in the book, does not necessarily give you stability. It can actually give you an anchor.

                             So if you’re offered a line of credit, should you take it or not?

Scott:                   Well I think you have to make that part of your – you have to think of it like your mortgage. Let me give an example that’s a bit out of the blue but I thought it up this morning on the train.

                             So average HELOC 70,000. So people don’t think much of that. They just kind of go, okay, sure that’s great. It’s over time, it’s not going to bother me.

                             But put yourself back in the scenario of when you bought your house if you bought in the last few years. It was more likely a bidding war if it was in the city. So what if you were all five or 10 of you in there were working with your agent trying to get that – removing this condition and that, and then it goes up another five and we’ve all got to go up 5,000 in our offers. If somebody came in and did a bully offer of 70,000 more than you were offering.

Doug:                   A bully offer is just way higher than what everyone else is offering.

Scott:                   Yeah, you were all in there battling at 800,000 and some jerk came in and said I’ll give you 870, and everybody said that’s crazy I’m out.

                             Well that 70,000 is exactly the same that you were offered by the bank in a HELOC. It’s just after the fact instead of at the front. So you would have freaked out at the bully offer, but no problem. The bank offers you 70,000 once you own the house, hey no problem. I’ll take it.

Doug:                   And 70,000 is 70,000.

Scott:                   It’s 70,000. It’s normalization right? People say 70. Right?

Doug:                   Yeah, you don’t say 70,000.

Scott:                   You say the whole amount every time.

Doug:                   Oh, that’s good. Say the whole amount.

Scott:                   Like 1.2. It’s one million, two hundred thousand. It sounds different right?

Doug:                   Yeah and so whether I pay 800 or 870 for a house, oh I’m not going that high. But to tack an extra 70 on at the end on a HELOC. No problem. And it’s the same 70.

Scott:                   It’s the same 70,000. In fact it’s 70,000 that’s subject to interest rate rises. Whereas if the 70 was when you bought, you probably locked it in at whatever. Right?

Doug:                   So you got much less risk. So I like that. There’s your practical advice tip for the day, say the whole number. Don’t say 70, say 70,000.

Scott:                   Call it what it is.

Doug:                   Call it what it is.

Scott:                   Treat it with the respect it deserves. It’s money.

Doug:                   So let me play devil’s advocate here. I can see why high interest credit card debt is a problem. But why – because it’s high interest. I get it. Why then are low interest HELOCs a problem. And I understand, okay, interest rates and everything. But 70,000 on a HELOC is a lot less of a worry than 70,000 on credit cards.

Scott:                   Right. But I think you take the whole picture of the economy into account, right? So that’s 70,000 right? Plus your 800,000 and give it the respect it deserves.

Doug:                   It’s not eight.

Scott:                   And then you have credit card debt of 30, 40, 50, in our case 70,000 average home owner. And you know, we’re in an economy where people are getting downsized, it’s the gig economy where anybody under a certain age is working, like, two side jobs plus they’re driving for Uber and they’re delivering food. And it’s such a precarious employment and income situation, and we see this in Joe Debtor, we see this in our work with people that income is usually the issue. Everybody’s living really close to the edge. Not everybody, but –

Doug:                   Big chunk.

Scott:                   By theory is there’s a significant chunk of Canadian society that is living very close to the edge. In other words could you absorb an impact of any kind? An impact being divorce. That’s a huge one. Job loss.

Doug:                   Well you have the flu and you’re off work for a week. That’s a big shock for a lot of people.

Scott:                   And if you – other studies show that nobody’s got any savings, so there isn’t a cushion there of cash – well that’s why you got your HELOC, I guess.

Doug:                   Exactly.

Scott:                   Savings are HELOCs now right? So I think when you look at – HELOCs are not a problem in and of themselves. But you’ve got to look at the whole thing you’ve got going on. Because when I have people call me as recently as yesterday who are homeowners with HELOCs and second mortgages and all kinds of stuff, they have a number of things going on in their lives, right? And so they’ve gotten to the place where they’re at where it’s taken time for all these little factors to come into play.

                             But it’s death by a thousand cuts again. So yes, the HELOC’s a good idea but make sure you can afford the thing if it changes. Make sure that you can afford all the other things in your life. So in other words, if you’ve got 30,000 in credit card debt, don’t take the HELOC. Not yet. Pay that down and then do it. You don’t need to do that right now. So it’s wants and needs, right?

Doug:                   Well so let’s finish this off then with your advice. So you just gave a piece of advice. I still think the best advice is say the full numbers. So we probably should have just ended the show right there.

Scott:                   One point two million.

Doug:                   One point two million dollars.

Scott:                   Say it like what’s his name in Austin Powers. Million.

Doug:                   It’s a big number.

                             So – but I think the next point you just made is, if you’re going to be getting a HELOC to pay off your credit cards, okay, I understand why that makes sense, cancel the credit cards then.

Scott:                   Yes.

Doug:                   Or lower the limits on them or something.

Scott:                   Oh yes.

Doug:                   Because paying them off and then racking them up again wasn’t really paying them off.

Scott:                   That’s the other big takeaway from this one folks, what Doug just said. We usually see – when people consolidate their debts the reason they come back in to see us again a year from now is because they didn’t cancel their cards. Right? So if you are going to tackle the debt before you take the HELOC, which is what you should do, cut the cards up. Because I can’t tell you the rate of recidivism on that stuff. If it’s there you’re going to use it again right?

Doug:                   If there was a $20 bill sitting on the table, one of us would pick it up because that’s just how it is.

Scott:                   I don’t think you’d beat me to it but one of us would get it.

Doug:                   We’d probably rip it in two as we went for it. That’s just the way it is.

                             So are there any other pieces of advice, then, that we haven’t hit on here that people need to be aware of?

Scott:                   Well, okay, so if you are in the kind of scenario where you’ve got all kinds of balls in the air, like the people that are calling us something, you’ve got a mortgage, maybe a second mortgage, maybe a HELOC. You and your husband or you and your wife are both working jobs where you’re not entirely – you’re not going to be there 30 years risk free. Your job could change. You could move. You’ve got a couple of kids, so those kids, they’re factors. They’re big factors right? Because okay they’re healthy right now, maybe they won’t be.

                             But without freaking people out, look at your entire picture and say okay, what are my big risks here? In any one of these things. Can I keep going here for even three months if anything happened?

                             And it never hurts to talk to somebody. Because I mean how many people that come to see us end up filing?

Doug:                   Well certainly less than half.

Scott:                   Right. So we talk to a whole bunch of people, thousands of people who we just give them advice on what they should do about debt and stuff like that. For free.

Doug:                   There are some people who come – yeah, and we’ll say, you know what? You’ve got a lot of equity in your house, so if you’re willing to cut up the cards then a HELOC maybe makes sense for you. Pay them off, and you don’t need to be doing a proposal or going bankrupt or anything like that.

Scott:                   And it costs nothing to talk, right? So if you have a lot of debt you’re not necessarily in trouble. But it doesn’t hurt just if you’re stressed out about it and if you’re thinking about it like that, just talk to somebody, right? Because at least you’ll know your rights. You’ll know what you can do, what you should do, what you shouldn’t do because often times it’s make sure you don’t do this or this because you’ll get in even worse trouble.

Doug:                   Yeah, stress is an excellent indicator of whether you’ve got a problem. So if I own a million dollar house and have a $500,000 mortgage, 500,000’s a huge number but I’m not really in that bad a problem there because I can sell the house and get out of it.

                             If I don’t own a house and I have $500,000 in debt, I’m probably toast unless my income’s a million dollars a year.

                             So I would be under a lot of stress in that situation. That’s a good indication that you need to reach out for help.

Scott:                   Yeah, absolutely.

Doug:                   Excellent. Well I think that’s a great way to end it and that tip again folks, say the whole number just in case you missed it.

Scott:                   And cut up your cards.

Doug:                   And cut up your cards.

                             Scott, thanks for being here today.

Scott:                   Thank you, Doug.

Doug:                   That’s our show for today. As always you can find a full transcript of today’s show and links to everything we talked about we talked about in the show notes over at Hoyes.com.

                             I’ll also put a link to Scott’s Twitter account so you can follow what he’s up to. He likes to go off on little Twitter threads about the people he’s met with and what’s happening. So that’s always entertaining.

                             And a reminder. You can subscribe to the video version of Debt Free in 30 on YouTube so that when Scott give the up to their chin symbol you can see it.

Scott:                   We’re on camera?

Doug:                   Absolutely. And the audio version is also available on all major podcasting apps including iTunes and if you like the show I’m always thankful if you leave a review.

                             Thanks for listening, until next week, I’m Doug Hoyes. That was Debt Free in 30.

The post Think Twice Before You Get a Home Equity Line of Credit appeared first on Hoyes, Michalos & Associates Inc..

Debt Consolidation May Not Work

Refinancing your debts through a debt consolidation loan means taking out a new loan and using the proceeds to pay off existing debt.  This means you stop making multiple monthly payments and only make one single payment to your new lender. The problem with this approach to consolidating credit is that you are still in debt. You also risk any assets you pledge as security if you are unable to meet the terms of your new consolidation loan.

There are 5 reasons why a debt consolidation loan may not work for you:

1. You will still have to repay all your debts, with interest.
2. Depending on credit score, the interest may be high, or you may be charged extra fees.
3. Your monthly payment may not be affordable.
4. You may not qualify for a debt consolidation loan.
5. You cannot borrow enough to deal with all your debt problems.

Any of these factors can increase the risk of debt consolidation which is why you may want to consider consolidating your debt with a consumer proposal instead.

Advantage of Consolidating Credit with a Consumer Proposal

There are several reasons why a consumer proposal may be a better debt consolidation solution when you are looking to consolidate credit into a single, lower monthly payment.

A proposal will still achieve one consolidated monthly payment, but that payment is lower because you make a deal to repay only a portion of your debts. In other words a consumer proposal provides the benefits of both debt consolidation and debt settlement.

There are several advantages of a consumer proposal over debt consolidation:

• Proposals are interest free
• You settle your debt for less than you owe
• They deal with all your debts
• No loss of assets or security needed
• You achieve a significantly lower monthly payment

Debt Consolidation vs Debt Settlement

Debt settlement involves negotiating a reduction in the amount you must repay to your creditors. A debt consolidation loan does not settle your debts for less than you owe. You must still pay back the full amount with interest. This is one of the things to consider when thinking about whether you should use debt consolidation or debt settlement when dealing with your debts.

A consumer proposal is the only legal, safe option to consolidate and settle your debts for less than you owe. Other solutions may consolidate debts, but they are not as successful at reducing your overall debt burden as quickly, or as securely as, a consumer proposal.

If you owe money on several credit cards, payday loans and other unsecured debts, chances are you have some debt problems. You likely do not have a large sum of money to pay off any of these debts or the ability to negotiate better payment terms on your own or through a debt settlement company.

Borrowing against the equity in your home is an extremely risky way to consolidate credit card debt and other outstanding bills. If you fail to make your payments, your lender can take action to foreclose on your home or take back what you have pledged as security for the loan. Second mortgages and unsecured consolidation loans can also carry a very high interest rate.

A consumer proposal, filed through a licensed trustee, provides the creditor protection you need while you work out a plan with your consumer proposal administrator to not only combine all of your debts into one, affordable payment, but fully settle those debts for less than you owe.

A Consumer Proposal Consolidates All Your Debts

If you are struggling with debt you will likely have more than one debt. You may not only owe money on several credit cards, but have outstanding bills, bank loans, payday loans and tax debts.

An advantage of using a consumer proposal as a form of debt consolidation, is that most unsecured debts are included in the proposal. This means that all your unsecured credit can be paid off in less than 5 years and you will truly finish the program debt free.

Learn more about how to file a consumer proposal or if you need help consolidating your debts, contact us today for a free, confidential consultation with a licensed professional. We will help you explore the best way to consolidate credit and make sure you get a fresh start. Let us help you explore all your options.

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If you have a low credit score, it is important to think through all your bad credit consolidation options before proceeding with any solution. You owe it to yourself to compare the costs of a debt consolidation loan with other debt relief options like a debt management plan or consumer proposal.

Should you even get a bad credit debt consolidation loan?

A debt consolidation loan sounds like a simple way to manage debt payments, save on interest, and pay down debt faster.

If the interest rate on your debt consolidation loan is lower than what you are paying on your credit card now, you can pay down your debt sooner because more of your monthly payment will go towards the principal than interest.

However, you need to have a good credit score or have assets you can offer as collateral to qualify for a low-interest rate loan.

The problem is, many people who find themselves struggling with monthly bill payments have a poor credit score – either because they have too much debt or because they have already defaulted on a monthly payment.

Having a bad credit score means most low-interest personal loan providers – from a bank or credit union, for example – are off the table. If your credit score is below 600, you will likely be looking at a very high-cost loan.

While there are lenders who specialize in offering unsecured debt consolidation loans to borrowers with low or very bad credit, a high-interest financing loan to consolidate bills may not be the best answer either. Bad credit personal loans appear attractive due to their repayment terms and low monthly payment, but the interest rates are often as high as 45.99%.  So, while not as bad as a payday loan, they are still not a good way to deal with problem debt. A personal loan like this can also carry origination fees or insurance requirements, which can double the cost. Always read the terms of the agreement carefully and understand your rights and responsibilities under the loan.

Traditionally a secured consolidation loan like a home equity line of credit or car loan offers a lower interest rate. However, if you have bad credit, even a secured consolidation loan can be costly.  Car title loans, for example, can carry an interest rate of 35% or more.

Here are 5 questions you should ask yourself before consolidating your debt when you have a low credit score:

1. What is the interest rate?
2. What additional fees will I be charged?
3. How much will I pay over the life of the loan?
4. Can I afford the monthly payments?
5. What are the penalties or fees for late payments?

Answering these questions honestly will help you determine whether bad credit consolidation loans are worth it.

If you can’t afford the monthly payment, then it’s time to consider a less expensive alternative if you are looking for debt help.

When to avoid bad credit consolidation loans

The larger your debt consolidation loan, the more challenging it will be for you to repay the loan. Bad credit consolidation loans above $10,000 are risky.

If the rate on your debt consolidation loan is higher than what you are paying today, it may not help you get out of debt. Smaller weekly or biweekly payments may look attractive, but most of those payments go towards interest.

A bad credit consolidation loan may not be your best option if:

• You are currently only making the minimum monthly payment on your debts
• Your debt-to-income ratio is above 40%
• The interest rate is higher than your current debt
• You can’t get enough to consolidate all your problem debt
• You have to commit to a lot of extra fees like loan insurance
• Your current outstanding balance is more than you can afford to repay
• You are at risk of a job loss or other income reduction that could lead to default

A debt consolidation loan may seem like the best fix, but it may not be.  It’s important to remember that a bad credit debt consolidation loan is still a loan, and lenders seek to profit from this product.  Most of your monthly payments will still be going towards the high interest on your loan. Extending your repayment period for many years will lower your monthly payment but can also delay your financial recovery.

What you need to do before applying

Before you complete any loan application, either in person or online, you should:

Check your credit report.  Get a free copy of your credit report from either Equifax or TransUnion. Fix as many errors and negative information regarding your credit accounts as you can. You will have to pay if you want to know your credit score. Improving your credit score, even a small amount, can increase your chances of qualifying for a lower interest rate.

Avoid multiple applications. Every time you apply for a loan, it is known as a hard hit on your credit report, which will be reported to the credit bureaus. Multiple applications will lower your credit score even further.

Prepare a budget. Use an online loan calculator to determine the maximum amount of monthly payment you can afford without continuing to go into debt. If you cannot find a loan that fits your budget, consider alternatives such as a debt management plan or a debt proposal to your creditors.

Consider options that lead to debt relief

Credit card debt, utility bills, cell phone bills, overdrafts are debts with one thing in common – these are unsecured debts that typically build up over time or that continuously recur because you have been using credit to pay for living expenses. Adding more bad debt, especially a high interest personal loan, won’t help you get out of debt.

If you have too much debt to be fixed through a consolidation loan, there are better options.

Debt Management Plan

If you are not eligible for a low interest consolidation loan, you may want to consider a debt management plan. A non-profit credit counsellor can work with you and your creditors to arrange a repayment plan.

You will be required to pay back 100% of what you owe; however, you will have up to five years to do so. Spreading out the payment of your current balance over five years can certainly lower your monthly payment. Since many creditors are willing to freeze interest, a debt management plan can be a better alternative than a high-interest consolidation loan.

A fee of 10% of the debts included in your debt management program will be added to your monthly payments.

There are disadvantages to a debt management plan. Participation by your creditors is voluntary, and student loans, payday loan debt, and income tax debt are generally not eligible through a credit counselling option.

Debt Settlement or Consumer Proposal

What do you do if you can’t afford to pay your bills? A better alternative may be to offer a debt settlement or consumer proposal to your creditors.

A consumer proposal allows you to consolidate many forms of unsecured debt, interest free, and you repay only a portion of the debt you owe. It is filed with a Licensed Insolvency Trustee, but you are not filing bankruptcy.

As a legal debt settlement program, a consumer proposal is binding on all creditors. It puts an end to harassing calls from creditors and any legal action taken against you like a wage garnishment.

But what about improving my credit score?

How does a bad credit consolidation loan affect your credit? While a personal loan through a financing company will look better on your credit history than missed payments, you will still carry a lot of debt. High debt balances affect your credit score negatively. Lenders also look at factors beyond the credit score they see. Subprime loans could still be viewed poorly if you try to apply for a future loan.

One of the most common reasons people with poor credit insist on searching endlessly for a low rate consolidation loan for bad credit is because they do not want to hurt their credit any further.  Many people are enticed by lending companies that offer to ‘level up’ your loan as a way to improve poor credit. Loan companies use a lot of terms: level up, lend up, ladder up. They all mean the same thing.

How do you level up a loan?

Make your payments for a specified period, usually, at least 12 months, and the lender will either increase your credit limit or offer you a lower rate loan.

The thing is, to qualify for an interest rate improvement, you must have a stable credit profile. That means no other hits to your credit report. No new loans, no re-drawing on your credit cards if this keeps your debt load high. And offering to increase your credit limit, when you are already struggling to repay your debt, is not a good deal for you.

The truth is that your credit score can improve quicker with a consumer proposal.

Why? Because no more debt is the fastest way to boost your credit.

Both a debt management plan from a non-profit credit counselling agency and a consumer proposal have the same effect on your credit report. Both will be viewed as a repayment program and will remain for a maximum of six years.

With a proposal, your monthly payments are much lower, which improves your overall cash flow.  Since you now have a balanced budget, you can begin to set aside some savings. At the end of the proposal, all your debts are eliminated. You start from zero, a clean slate.

A consumer proposal can help you rebuild your credit by removing old debt. In effect, you are resetting the clock. Old debt is gone, lowering your utilization rate. Over the next couple of years, you can begin to build a new and better credit history.

Improving your credit score involves a few steps.

1. Eliminate high interest debt.
2. Save an emergency fund or down payment, so you don’t have to rely on so much credit.
3. Apply for a secured credit card to re-establish a positive credit history.
4. Keep all your bill payments current and pay any balances in full each month.
5. Limit your credit consumption going forward.

What to do when you need debt help with bad credit

If you’re having trouble staying on top of bills or credit card debt payments and your credit score is limiting your ability to get an affordable loan, talk with a Licensed Insolvency Trustee about your options. 

Debt problems are not solved by taking on more debt. You need to look beyond a high cost bad credit debt consolidation loan.

A trustee will run the numbers, based on your personal financial situation, and help you compare a consumer proposal with a debt consolidation loan to see which program can achieve your debt consolidation goals and get you started on repairing your bad credit, all while eliminating your debt.

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A natural impulse to being short on cash is to use a loan in the form of credit. There are so many options out there with credit cards, lines of credit, and payday loans, a new loan can be difficult to resist. But ease of access just makes it harder to draw the line, because what you really need to do is ask yourself “is this new loan a good idea?” A good way to gauge whether or not getting another loan a good idea is to think of the big picture. Is the relief temporary, or will this help your financial situation in the long-run?

When is it a GOOD idea?

If it provides you with a long-term solution.

Getting another loan is a good idea if you have a stable financial foundation and a strong history of repayment. If you’ve historically had a regular income, paid your bills on-time and have minimal debt, you’re most likely able to repay your new loan over time. Unexpected costs can shock every one of us and yes, at times we all may need to take on unexpected debt.

Before you do, make sure you assess your situation. Are there assets that you can sell or funds that can be borrowed against a lower interest rate to help repay the debt? If the chances of you being able to repay that debt are strong, then getting another loan is a good idea. Remember to use tools like our debt repayment calculator to help keep your scenario as realistic as possible.

When is it a BAD idea?

When you mistake credit as a substitute for cash. 

Having credit may sound positive because it essentially means that someone else trusts you. You’re using someone else’s cash to acquire something because they trust that you’ll pay them back. However, using credit means having debt. If you have poor credit, you could find yourself paying close to the maximum interest you can be charged in Ontario.

I see people every day who are unable to break free from the cycle of debt. If the only available credit comes with high interest charges, you are shackling yourself to the same problems that you are trying to get away from. It’s important to identify if you’re mistaking credit as a substitute for cash. Can you realistically afford to repay that new loan? If you’ve recently had a significant reduction of income, are in the middle of a divorce or already have a mountain of debt, taking on a new loan is probably a bad idea.

Look for Real Solutions

Having too much debt and needing to take on a new loan is just a symptom of the real problem.  Accumulating debt is a result of your expenses exceeding your income.  Using credit can help maintain balance between the ins and the outs of your income, but it comes with the burden of eventually repaying the debt – and with interest.

If you were in a situation where your existing debt was eliminated, how would you look financially? Was your debt a result of a short-term shock to the system? Or were they a result of a shaky foundation?  Do your expenses exceed your income? If so, are there changes that you can make to your expenses to help balance those levels?

If you identify with any warning signs of having too much debt, it may be time to call in a professional. Identifying patterns to make sound financial decisions for yourself is difficult when you don’t know where to start.

A phone call or free consultation with a Licensed Insolvency Trustee can help you analyze the causes of your financial difficulty, as well as the most effective way to get your debt under control.

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