Area of Law: Credit, Debt and Bankruptcy
Answer # 0273
Debt consolidation and informal arrangementsRegion: Ontario Answer # 0273
Although personal bankruptcy allows you to make a fresh start, free of most of your debts, if you have a steady income and a satisfactory credit rating, you may want to consider other options with less serious consequences. One of these is debt consolidation.
Debt Consolidation Loan – from your financial institution
Debt consolidation refers to consolidating all of your debts into one. A debtor can apply for one new loan which covers the total amount owing all of the existing creditors. The proceeds from the debt consolidation loan are used to repay the existing creditors. This way, the debtor will then have only one payment to make to the new lender, which is usually a financial institution, such as a bank or trust company.
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What debts can be consolidated?
The most common debts you can consolidate are:
- credit card balances
- public utilities
- other consumer loans, including lines of credit
Advantages of a debt consolidation loan
A debt consolidation loan is a good idea for three reasons:
- Once you pay off what you owe using the loan, you will then only have to make one payment each month instead of multiple payments to your credit card providers or other lenders.
- The interest rate will generally be lower than the interest rate on your credit cards or other consumer loans.
- The debt will be paid off in a set amount of time (typically 2 – 5 years).
Disadvantages of a debt consolidation loan
There are also disadvantages to debt consolidation loans, including:
- you must qualify for the loan with your financial institution, generally by having a good credit rating and sufficient income to make the consolidation payments
- if your credit rating or income is not acceptable, you may have to provide some kind of collateral (e.g. lien on personal property such as a vehicle, or a mortgage on real property, such as your home) in the event you cannot make your payments
- although the loan may have a reduced interest rate and it replaces multiple smaller payments each month, you must still be able to afford the one larger monthly payment
- if you miss payments or make late payments, your credit score will decline
How will a debt consolidation loan affect my credit score?
Having a debt consolidation loan will typically affect your credit score in a positive way because the existing loans are reported as paid in full and removed from your credit report. Although taking a new loan is added to your credit history, if you consistently make your new loan payments on time, this will also positively affect your credit score over time.
A debt restructuring agency can help you apply for a debt consolidation loan and provide advice and help with other solutions to eliminate your debt.
Informal arrangement with creditors
If you cannot obtain financing for a debt consolidation loan, you may be able to make an informal payment arrangement directly with your creditors. They may agree to let you pay a lesser amount, or make your payments over a longer period. You should first learn how your credit rating will be affected before agreeing to such arrangements. Sometimes creditors agree to reduce your debt or extend the repayment term, but will still report you to the credit bureau.
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