The 2021 Financial Stress Index revealed that almost 40% of Canadians saw money as their top concern. So much so, that 51% of survey respondents admitted to losing sleep over their financial worries.
If that’s you, then you’ve already dealt with the hopeless feeling of having credit card debt. You’ve likely experienced deep-seated anxiety when checking on your bank account. And you know, in your gut, that this is no way to live.
Fortunately, you don’t have to spend the rest of your life wondering how to pay off your credit card debt. You can consolidate your credit card debt and become debt-free in less time than you think.
We’re going to cover the basics of debt consolidation. And then we’ll talk about the pros and cons of paying off credit card debt with debt consolidation.
Sound good? Keep reading to find out more.
What You Should Know About Debt Consolidation
Personal finance experts pretty much all agree that debt consolidation can be a powerful financial option. But Canadians aren’t always clear about what debt consolidation is or how it works. Here are three key facts about debt consolidation that everyone should know:
1. Debt Consolidation Combines Debts
In personal finance, it’s not unusual for people to think that debt consolidation wipes out entire debts. While these loan amounts are used to repay your current creditors, the debt payoff angle only tells half the story.
Let’s say that you owe $10,000 on Credit Card A, $5,000 on Credit Card B, and $2,000 on Credit Card C. Instead of making three different payments every month, you can take out a $17,000 consolidation loan.
In this scenario, the loan you’ve taken out can cover the outstanding balances on all three credit cards. But even so, the $17,000 debt doesn’t disappear. It gets pooled together into a single loan.
That’s debt consolidation in a nutshell.
2. You Can Renegotiate Your Repayment Terms
Imagine you’ve taken out your debt consolidation loan. You’ve been making your payments on time. And, now that you’ve gotten the hang of things, you’ve paid off a significant chunk of your loan.
Everyone has a few quibbles with their repayment terms. Maybe the dollar amount is stretching you a little thin. Perhaps with a stronger credit score and a new job, you’re 99.9% sure that you could land a more favorable interest rate.
You’ve heard of people refinancing their mortgages after ten to fifteen years. If you’re a homeowner, you may have even gone through the process.
Believe it or not, you don’t have to grit your teeth and power through a loan repayment that isn’t working for you — you can refinance your loan and get better terms once you’ve paid off some of your balance.
3. There Are Multiple Debt Consolidation Options to Choose From
When most people hear the words “debt consolidation loan”, they immediately start thinking of personal installment loans. But although personal loans may be a well-known method of credit card debt repayment, they’re not the only option available to you.
Common debt consolidation methods include:
- Credit card transfers
- HELOCs (Home Equity Line of Credit)
- Mortgage refinancing
- Lines of credit
In summary, debt consolidation is a financial strategy. You have more control over the exact repayment mechanism than you might think.
The Three Pros of Credit Card Debt Consolidation
So we’ve covered some key facts about debt consolidation. However, it all begs the question:
What are the benefits of paying off credit card debt this way?
In our experience, there are at least three compelling reasons to consolidate your outstanding credit card balances.
1. You Can Get a Lower Interest Rate
Have you ever reviewed your credit card statement at the end of the month? If you did, you probably noticed that your minimum payments were going towards paying off interest.
With a lower-interest item, like a house or a car, you might not even notice the amount of interest you’ve been paying. But with a credit card, a hefty percentage of your payments are going towards interest.
Whether you choose to go with a personal loan or a HELOC, you’re guaranteed to be getting a lower rate than what you would be paying on your credit cards. But there’s another reason why debt consolidation is often associated with reduced interest:
You’re only charged for interest once.
If your credit cards have a combined interest payment of $150, that’s $1,800 a year that’s not being put towards paying down the principal. Between the lower initial interest and the single monthly interest payment, debt consolidation can help you save big as you work your way towards becoming debt-free.
2. You Can Simplify Your Finances
In 2020, Canadians were expected to save roughly 3.21% of their disposable incomes. This added up to just $1,277 per household.
Depending on where you live, that might not be enough to cover a single mortgage payment. Never mind a solid savings strategy.
One of the most important benefits of debt consolidation is the way that it lumps multiple payment dates into a single, once-a-month affair. You can’t underestimate how that element of predictability can give you peace of mind and enough breathing room to start planning for your future.
3. You Can Increase Your Credit Score
At first glance, this one might sound a bit counterintuitive. After all, can paying off debt with more debt really help your credit score?
It turns out that it can on two fronts:
First, your loan can improve your credit utilization. If you have a credit limit of $20,000 and $19,000 is tied up in credit card debt, that will reflect in your credit score. If you take out an additional $19,000, however, suddenly you’ve got a credit limit of $39,000 and a $19,000 debt.
And once your credit utilization has gone from “needs improvement” to “great”, your credit score will go up accordingly.
Second, whether you’re taking out a HELOC or a standard loan, debt consolidation is fundamentally a loan. That means that as you make your payments on time, you’ll be able to strengthen your payment history.
Talk about a surprising benefit!
The Three Cons of Credit Card Debt Consolidation
You may have read through that list of pros and thought, “What’s the catch?”. No financial strategy can be that effective, right?
As it turns out, for all the benefits of consolidating your debt, there are downsides that you’ll want to be aware of:
1. You Need to Have the Right Amount of Debt
Although the financial benefits associated with consolidating credit card debt are undeniable, you do need your debts to be the right size.
If the debt is so small that you’re a month or two away from paying it off, it might not make sense for you to go to the trouble of consolidating your debts. But if your debt has gotten to the point where you’re struggling to make your payments, debt consolidation may not be the right solution — you may need to negotiate with your creditors.
2. You Need the Right Borrowing Amount
Imagine you owe a total of $20,000. But after applying at the bank, the loan officer calls you and says, “We’re sorry. We can’t approve a loan of more than $10,000.”.
It happens more often than you think.
The more your debts pile up, the more reluctant lenders will be to extend more credit. This can eventually put you in a situation where you’re unable to qualify for the loan amount you need.
To be clear, all isn’t lost in this scenario. You may be able to consolidate your two smallest credit card debts while continuing to pay off the other one. But either way, the shrinking approval amounts are an issue that you’ll want to be aware of going in.
3. It Has to Be Part of a Holistic Financial Plan
Debt consolidation isn’t a silver bullet. Far too often, people buckle down and repay their loans only to end up with even more debt than before.
Why? Because these individuals have never learned to change their spending habits.
For this reason, it’s often recommended that Canadians go a step further while crafting their debt consolidation strategies. Don’t pay down the debt and start spending all over again. Create a budget and a long-term spending plan.
Your finances will thank you for it.
Wipe Out Credit Card Debt With Debt Consolidation
If there’s one thing Canadians can agree on, it’s that credit card debt is no one’s idea of a good time. But if you’ve been thinking about tackling one debt at a time, there’s a simpler and cheaper option:
You can choose debt consolidation.
Although this is a decision that will lower your interest rate and simplify your finances, factors like the amount of debt and the loan you can qualify for can all affect your debt consolidation strategy.
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