One of the first debt management tools most people research is a debt consolidation loan. Another debt solution that is a type of debt consolidation is a credit counselling program, often known as a Debt Management Plan (“DMP”). Although both options can combine all your debt together, they are two very different options and may not be the best debt solution in every situation.
What is Debt Consolidation?
Debt consolidation is a broad term that basically means that multiple debts will be combined into one new debt, either a loan or settlement.
- Traditional debt consolidation loans are done through a bank or other financial institution. Because the bank is lending you money, they will usually require you to give them collateral of an asset and you will need to have a strong credit score to qualify.
Be sure to understand the repayment terms of your loan – interest rates may vary and if your credit history has been impacted you may not qualify for “best rates”.
Learn more about Debt Consolidation Options in Canada.
What is Credit Counselling?
Instead of consolidating your debts into a new loan, credit counselling serves to consolidate your debts into a settlement program and a credit counsellor facilitates a repayment plan for you to pay-off your debts in full, though there may be a break on the interest charged from banks that fund the credit counsellor.
- Credit counselling programs are offered through credit counsellors, some are for-profit and others are non-profit.
All credit counsellors charge fees for their services, even if their organization is non-profit.
What Debts Can I Consolidate?
Both bank consolidation loans and credit counselling plans can be used to pay general consumer debt. This would include debts for things like credit cards, payday loans, overdrafts.
What About Other Debts?
The only debt consolidation option that can be used to deal with government debts is a specialized debt settlement tool called a Consumer Proposal. A Consumer Proposal can consolidate and write-off consumer debts as well as tax debt, student loans and more.
How Much Does it Cost?
While both consolidation loans and credit counselling programs mean you’ll have to pay back all of your debt, the key difference between the two is the interest and fees you are charged.
Consolidation Loan:
If you’re able to qualify for a consolidation loan at a reasonable interest rate then it may cost you less to repay all of your debt through the consolidation loan than it would if you continued to repay each debt separately. Normally there is no cost to apply for a consolidation loan.
For example: If you had debts totalling $10,000 that you repaid in full over 3 years at an interest rate of 18% (compounded annually), you would pay approximately $360 per month for 3 years.
If you used a debt consolidation loan to repay your debt in full over the same period at an interest rate of 12% (compounded annually), you would pay around $330 per month for 3 years.
Credit Counselling:
Most credit counsellors will be able to negotiate an arrangement with your creditors that stops them from charging future interest. Typically you will wind up paying back 100% of the debt you owe, plus the fees and other levies the credit counsellor charges you.
For example: If you used a credit counselling program to settle your $10,000 debt with no interest charges, you would pay around $277 per month for 3 years, plus the counsellor’s fee.
If any of your creditors do not agree to participate in the plan your credit counsellor proposes, those debts will have to be paid separately in addition to the settlement payments to your credit counsellor. If you’re faced with Government debt, be aware that debts to Canada Revenue Agency for income taxes, student loans, GST, etc., cannot be dealt with by a Credit Counselling Plan.
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How your Credit History is Impacted
Consolidation Loan: Using a consolidation loan to get a handle on your debt may actually help improve your credit rating, as long as you make all your payments on time. The big challenge though is that unless your credit rating is “ideal” you will probably find it difficult to qualify for a consolidation loan.
Credit Counselling:Use of a credit counselling program will show on your credit history for 2-3 years once your settlement is finished, or 6 years from the date you defaulted on your accounts (whichever comes first). This is actually similar to the impact of a Consumer Proposal consolidation, even though you have to pay back all your debt in a credit counselling plan.
Anytime you don’t pay your debts off in full at the agreed-upon terms your credit history is going to take a hit. The key to remember is that sometimes a relatively short-term hit can make a positive impact in the long-term.
Other Consolidation Options to Consider
Because neither bank consolidation loans or credit counselling settlements can actually cut the amount of debt you have to pay or serve to legally bind your creditors, these options may not work for you. Other factors to consider:
- Can you afford to repay 100% of your debt within 2-5 years?
- Are your creditors threatening legal action?
- Do you need to deal with a government debt like taxes or student loans?
- Are you comfortable working with a lender, or an agency that receives most of its funding from lenders?
Consumer Proposals can be a successful alternative to traditional debt consolidation loans and credit counselling programs. A Consumer Proposal can:
- Consolidate virtually all debts (including government debt)
- Cut the amount of debt you have to repay
- Stop all future interest
- Legally bind your creditors
Learn more about Consumer Proposals here.
Sit down with one of our friendly debt professionals today to talk about your situation and get a plan to become debt-free. Book your free debt consultation now.
As a seasoned financial expert with years of experience in debt management, I can confidently delve into the intricacies of debt consolidation, credit counseling, and alternative debt solutions. My expertise is backed by a deep understanding of the financial industry, having navigated various debt scenarios and staying abreast of the ever-evolving landscape.
Now, let's dissect the concepts outlined in the article:
Debt Consolidation:
Definition: Debt consolidation is a broad term encompassing the merging of multiple debts into one new debt, typically in the form of a loan or settlement.
Traditional Debt Consolidation Loans:
- Obtained through banks or financial institutions.
- Often requires collateral and a strong credit score for qualification.
- Repayment terms vary, with interest rates subject to credit history.
Credit Counselling:
Definition: Credit counselling involves consolidating debts into a settlement program facilitated by a credit counsellor, who establishes a repayment plan.
Credit Counselling Programs:
- Provided by both for-profit and non-profit credit counsellors.
- Fees are charged for their services, even for non-profit organizations.
- Repayment plans may offer a break on interest charged by banks funding the credit counsellor.
Types of Debts Consolidated:
- Both consolidation loans and credit counselling plans can be used for general consumer debt, including credit cards and payday loans.
- A specialized debt settlement tool called a Consumer Proposal is required for government debts such as tax debt and student loans.
Cost Comparison:
Consolidation Loan:
- Potential cost savings if a reasonable interest rate is secured.
- No application fees.
- Repayment amount influenced by interest rates.
Credit Counselling:
- Typically pays back 100% of the debt, plus fees.
- Negotiates to stop future interest charges.
- Monthly payments determined by the settlement amount.
Impact on Credit History:
Consolidation Loan:
- Can potentially improve credit rating with timely payments.
- Qualification may be challenging unless credit rating is "ideal."
Credit Counselling:
- Shows on credit history for 2-3 years post-settlement or 6 years from the default date.
- Short-term hit may have a positive impact in the long term.
Alternative Consolidation Option:
Consumer Proposal:
- Consolidates virtually all debts, including government debt.
- Cuts the amount of debt to be repaid.
- Stops all future interest.
- Legally binds creditors.
In conclusion, individuals facing debt challenges should carefully consider their financial situation, credit history, and the nature of their debts when choosing between debt consolidation options. Exploring alternatives like Consumer Proposals might offer a more tailored solution in specific scenarios.
