How to Use Debt Consolidation to Save Money

If you are like most Canadians, you have credit card and other forms of debt. While some types of debts, like mortgages or student loans, can help you move forward, others, including credit cards, can hold you back. If you have too much debt with high interest rates, you may find yourself in a cycle of debt payments with no end in sight.

Debt in Canada is rising. Average Canadians now have an average of $20,722 in debt, not including their mortgage [1]. As prices rise in Canada, consumers are using credit cards to help bridge the gap, and then statistics show that they are paying the card balances down more quickly [2]. This can lead to high balances with high minimum payment – effectively hijacking your budget and paycheques. 

Fortunately, debt consolidation offers you a simple way to break free of growing debt problems. 

What is debt consolidation?

Let’s say that you have four or five credit cards. Perhaps a couple of retail store credit cards, a card that you used to take advantage of a discount when buying something at a furniture store, and a standard credit card or two. Each of those credit cards has a minimum payment each month that is a (very) small percentage of the balance on the card.

If you pay just the minimum amount on the credit cards, you’ll spend years paying off the card. And if you continue to use the card while paying the minimum payment, you’ll never pay it off and you’ll be caught in the credit card debt cycle indefinitely. 

Debt consolidation offers you ways to pay off the four or five smaller credit cards with a single sum, perhaps a larger personal loan or through credit card balance transfers. If you set up a debt consolidation loan, you’ll pay off the credit cards and any other small loans with the proceeds of that loan. Then, once the credit cards are paid off, you’ll have a single installment loan to pay off instead, often with a much lower monthly payment than your credit cards combined. 

Using debt consolidation can also help improve your credit score rating through positive payments.

Debt consolidation options

If you’re looking to debt consolidation to help you get out of debt, you have some options. The overall goal is to find an affordable, larger sum of money that you can use to pay off the smaller, more expensive debts. 

Credit card transfers – If you have good credit, you may be able to open a new credit card that has a special offer for a zero percent interest rate for balance transfers. Once you have a credit card with a low or no interest rate for balance transfers, simply transfer all the smaller balances to the new card. 

Once they are consolidated on the new card, combine all your previous monthly minimum payments, and pay that amount (plus more, if you’re able) toward the new card until you’ve paid the balance off completely. To make this successful, you will need to pay the complete balance before interest rates begin again on the new credit card, especially if that interest has accumulated during the introductory period. 

Installment loans – Personal loans are an easy way to get started with debt consolidation. Even if you have bad credit, there are lenders who are willing to work with you to take out a new personal loan. A personal loan is an installment loan, much like a car loan, that will have regular monthly payments. But unlike a vehicle loan, a personal loan is not tied to a particular purchase. 

Instead, you apply for a new personal loan, and once the lender approves the loan, the money will be transferred to your bank account for you to use for any purpose. In the case of debt consolidation, you’ll want to use those funds to pay off the smaller credit cards. Then you’ll be left with only the single, set monthly loan payment. 

And the best part of installment loans is that unlike credit cards that continue to grow over time, when you’ve made all the scheduled payments, you’ll have completely paid off your debt.  

Tips for successful debt consolidation

Debt consolidation can be a powerful way to take back control of your financial life. Through debt consolidation, you’ll go from spending large amounts of money on multiple minimum payments every month to paying off your debts completely with a lower payment, giving you back some breathing room in your budget. 

Of course, you’ll want to be sure debt consolidation is the right option for your personal situation, and you want to set yourself up for success in the process. Here’s how: 

Research your debts carefully. You should know the full balances and the interest rates for all your debts before you begin the debt consolidation process.

Debt consolidation works because you pay off many smaller debts with a loan or line of credit that has a lower interest rate than the debt you’re paying off. It doesn’t make sense to pay off an expensive credit card with another expensive credit card or loan. 

Check to be sure there are no additional fees for paying off your other loans early. In some cases, you have a smaller loan with a prepayment penalty. If this penalty is high enough, it might not make mathematical sense to pay off that particular debt early.

Check for different debt consolidation options. You have choices about how you pay off the more expensive loans in your life. Consider comparing loans from different lenders to see which can give you the most favorable terms. If you are comfortable doing so, borrowing money from a friend or family member might also be a solution if you don’t like the terms lenders are offering. 

RELATED: What To Know When Getting Personal Loans

Mistakes to avoid with debt consolidation

While everyone hopes that debt consolidation works correctly and they wind up debt free and back in control of their financial life again, mistakes do happen. Be wary of some of the more common mistakes that happen with debt consolidation. 

Close the paid off accounts – Once you’ve used the proceeds of a personal loan or line of credit to pay off old credit cards, close them. If you leave them open and ready, you might find yourself charging them up again with new spending. 

Watch for high interest rates and do the math – Watch the interest rates and fees that come with your debt consolidation loan or line of credit. If it costs more to pay off your new debt consolidation loan than the minimum payments on your current debts, you’ll need to find a different debt consolidation option. 

Avoid predatory lending practices – There are some companies that offer debt counselling or debt settlement services, hoping to take advantage of Canadians looking to pay off their debts. These companies will often promise to help organize a debt consolidation service of some kind, but in practice often make situations worse by delaying card payments, damaging your credit, or charging extra fees for their questionable services.  

[1] https://www.cbc.ca/news/business/rising-credit-card-debt-in-canada-1.6571516

[2] https://www.theglobeandmail.com/business/article-canadian-credit-card-debt-rising/


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