Should You Consolidate Your Debt?

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Today I wanted to cover the subject of debt consolidation. What is it? Should you do it? and if so, then what are the options available to you?

But before we get into that I just wanted to give a shout out to one of the show’s sponsors which is Canadian MoneySaver Magazine. As a Build Wealth Canada listener you have access to a promo code that you can use to get a discount on the magazine, plus get free access to a recent paid webinar hosted by 31 year investing industry veteran Peter Hodson where he shares some of the lessons learned from investing in the past year, and what to watch out for this year. You can get the discount and the free video presentation over at buildwealthcanada.ca/magazine

Alright so let’s get into talking about debt consolidation. The idea behind debt consolidation is that if you have different debts at different interest rates, then what you can do is turn all those loans into just a single low interest loan.

The advantage of this, is that from a cost savings perspective, you could actually save money on interest since if for example you have a balance on a few credit cards, instead of paying 18% interest on each one of them, you can instead get one loan at a much lower interest rate, and use that money to pay off all those credit cards.

When you do this you’ve in a way converted the credit card debt, (since each credit card is basically a loan) and turned it into a single loan that is at a lower interest rate.

This money savings component can be nice, plus it lets you pay off your loan faster since any money you save from the lower interest payments can be used to pay down the debt quicker.

You can also do this with more than just credit card balances too such as car loans, and other loans you may have arranged in the past.

The other neat advantage is that now you no longer have to waste time managing multiple loans and/or credit cards. From an administrative perspective it’s just easier to deal with one loan instead of multiple smaller loans.

For example, every loan or credit card has a statement that looks different, they might have different minimum payments, they might have different rules and terms that you have to follow, and each has their own fine print.

If you consolidate, you can actually save yourself time as you’re just dealing with one loan, and you only have to learn and understand the one loan instead of a whole collection of them.

Now there are different ways that you can consolidate your debt. For example, you can do it yourself by for example getting a home equity line of credit which is also known as a HELOC.

When you use a HELOC to execute the debt consolidation technique, you basically take out a loan that is secured against your house, and use that money to pay off the high interest debt like credit cards.

Now of course if you mess this up and can’t repay the loan, the bank can foreclose on your house so obviously this is something that you have to be aware of.

Still, this is one way that you can consolidate your credit and the reason that it works is that the interest rate you get on a home equity line of credit (HELOC) will generally be a lot lower than what you’re paying on your credit cards and so the math makes sense.

Now of course there are a few cons and dangers of doing this.

The main con of doing this (which I already briefly brought up earlier), is that let’s say you execute this strategy but instead of paying off the debt, you keep racking up more and more debt.

Eventually you max out your home equity line of credit (HELOC) and perhaps start taking on more debt by using those credit cards again and maxing them out.

Of course by doing this, your monthly interest payments (i.e. your monthly debt obligation) gets larger and larger because you’re taking on more and more debt.

Therefore if you don’t control your spending, those interest payments could eventually get out of hand, and eventually get to the point where you can’t pay them anymore. Now you can run into the danger of the bank foreclosing on your house, and having your credit rating destroyed.

If you make this mistake, then you’re actually in an even worse situation than before (ie. than with just credit card debt) because now you have an even bigger loan to pay off, plus you once again have all the credit card debt that you also now have to pay off.

In other words, you’re actually worse off than you were if you just stayed with the credit card debt.

This is why you have to tread very carefully when it comes to this because if the core underlying issue is that you have a spending problem for example, then just consolidating your debt isn’t going to fix that.

In fact, in can make you even worse off. Therefore it’s important to look at the whole picture and for example consolidate your debt, but also examine why you got into that debt in the first place, and what can you do to prevent getting buried in debt in the future?

The other downside of using a home equity line of credit (HELOC) is that if you don’t own a home, then you obviously can’t do this since the loan is secured against a house that you own (in other words, the bank says that they will loan you the money, but your house is used as collateral which means that if something goes wrong and you can’t pay your debts to the bank, then they can take your house).

Now you can try to get other loans that are lower than your credit card interest rate for example even if you don’t own a home, but generally the interest rate that you will be paying will be noticeably more than what you would pay with a home equity line of credit.

This is why home equity lines of credit are a popular option if you want to consolidate your own credit because banks see your home as something secure that they could sell if things go wrong, and therefore because it’s secure, it means their risk is lower, and so they can offer you a lower rate.

Now the other disadvantage is that to get a home equity line of credit you will be charged a fee.

The bank will generally want to appraise your house (ie. determine its value so they know how much of a loan they are willing to give you). They generally aren’t willing to do this for free since it costs them money to do his, and so it can definitely cost you some money in fees to set this all up.

The process takes some time to implement because they have to appraise your house, analyze what they’re willing to do, and then give you an offer. Then you need to read it over and decide whether you agree with the terms or not.

These are some of the main reasons why I like the 2nd available option which is to work with a non-profit company to help you with the whole process such as:

1. To help you get out of debt.
2. To help you solve any underlying spending issues you might have
3. Potentially get you a lower interest rate than you might be able to get yourself (thereby helping you get out of debt faster).

My guest today is actually the founder of such an  organization and in a moment you’ll actually get to hear me pick his brain about the whole process, the pros and cons, and what to look out for when implementing this strategy.

I’ve always been curious about organizations like this because some of them (like the one with our guest today) actually help Canadians with the underlying issue (which is preventing them from getting into debt trouble in the first place), as opposed to just offering a low interest consolidated loan which as I mentioned earlier can actually make you worse off if you’re not careful and don’t solve the underlying debt accumulation issue.

Also since they do this type of work every day on a massive scale, I can see how that gives them extra negotiating power and expertise when dealing with other people’s creditors, and how they might be able to get a lower interest rate for Canadians than you and I can get ourselves, just because of the sheer volume that they do.

If I was in a situation where I needed help with debt, I would definitely be open to letting a company like this take a look to:

1. See if they can solve the underlying issue so that I can get out of debt and stay out of debt long term.
2. Let them do some research for me on competitive rates out in the marketplace and offer me a rate that is lower than what I’m currently paying (so that I can use those savings to pay down the debt even quicker and get out of debt even faster)
3. Get them to simplify things and save me time by making it so that I only have to deal with one loan (instead of a bunch of loans)

What I do like, is that it’s not like you have to pay money up-front to get them to do this for you. Therefore if you don’t like what they propose, you can always walk away.

Regardless of your decision, it doesn’t hurt to at least let them look into what they can do for you since it might be better than what you can get  yourself (such as a lower interest rate, plus they can try to help you solve that underlying issue that’s causing all the debt to accumulate in the first place).

This type of service and benefit is something that you just don’t get if you decide to just consolidate your own debt through a home equity line of credit for example.

To give you some more insight on this, my guest today is Jeff Schwarz who is the founder of Consolidated Credit Counseling Services of Canada.

If you want to learn more about Jeff’s non-profit organization that helps Canadians with this, you can speak to someone from his team for free by going to buildwealthcanada.ca/debt

Questions Covered

1. What does it mean to consolidate your credit, and in what circumstances should somebody consider doing this?
2. A common argument against credit consolidation services is that they don’t solve the underlying issue. In other words, somebody might consolidate their debt which frees up space on their credit cards or line of credit, and then they just end up taking on more debt since they haven’t changed their lifestyle and habits to live a debt free life. How can someone prevent this from happening to them?
3. Since you deal with a lot of individuals that have gotten into significant debt and are struggling to get out, what are the most common mistakes that you see people make that get them in this situation in the first place?
4. What are you thoughts on the use of emergency funds? Some experts suggest keeping it in cash, while others suggest having a line of credit for emergencies and using any available cash to pay off the debt. Where do you stand on this debate?
5. After paying off any high interest debt, what are your recommendations on paying off student loans and the mortgage vs investing the money for retirement?
6. For somebody that wants to see if consolidating their credit is right for them, what is the process that they get taken through with you from beginning to end?

In Closing

If you want to see if Jeff and his team can help you with any debt troubles you may have, and potentially get you a lower interest rate on your debts so you can actually get out of debt quicker, then you can chat with them for free by heading over to this link.

Have a wonderful week. Cheers.

Kornel