Debt Consolidation Loans & Bad Credit
If you have bad credit, you may feel like you are out of options when consolidating your debt. However, this is not the case! There are several ways that you can consolidate your debt, even if you have a low credit score. In fact, Debt consolidation is one of the methods we discuss in our 10 ways to pay off debt fast article. In this blog post, we will discuss several methods that you can use to get your debt under control.
Consolidating debt when you have below-average credit can be incredibly difficult. Most banks will not even try to submit a loan application which may leave you believing your only option is to go to one of the high-interest, predatory-lending, type institutions or even worse, payday lenders.
In this article, we are going to answer whether or not debt consolidation loans for bruised credit or bad credit are a good idea. We will also cover the other debt consolidation options that are available to you no matter your credit score.
Are debt consolidation loans even a good idea when you have bad credit?
The answer to this question really depends on your exact financial situation. In general, if you have sufficient income to support the debt consolidation loan payment, then a debt consolidation loan, regardless of the interest rate, will not cripple you and potentially allow you to get ahead without further damaging (and potentially even improving) your credit.
However, we regularly see that people who seek out debt consolidation loans are unable to actually afford the new payment. This leaves them in an extremely vulnerable state that pushes them further into the hole and can further worsen their credit.
We most often see this when people assume that a single monthly payment on a new debt consolidation loan is going to be easy to manage, even if in reality it is the same amount as the total of the previous debt payments. While it may be easier to manage in terms of remembering when the payment due date is and tracking if it is paid or not, if the payment is the same size or higher than the combined total of the previous payments you may still be stuck in a position where you struggle financially.
So should I get a debt consolidation loan?
We certainly do not think consolidation loans are a bad idea. In fact, in many instances, they can be a great idea and sometimes better than the alternatives we will discuss shortly.
A debt consolidation loan is typically a personal loan or line of credit that is used to pay out and consolidate other debts you have.
A debt consolidation loan is usually best suited when used to consolidate credit card debt, payday loan debt, or other high-interest debt. However, they can also be used to consolidate debts that have high monthly payments. This does involve stretching out the time it will take you to pay back those specific debts, but if cash flow is a problem it can be worth it because your monthly payment may be reduced.
We also caution against getting a secured consolidation loan to consolidate unsecured loans unless you have thoroughly run the numbers. Unsecured debt consolidations loans carry much lower risks.
For an unbiased review of your situation do not hesitate to reach out to us for help.
The different ways to consolidate debt, even if you have a low credit score
The main options available to you are as follows:
- Consumer Proposal;
- Bankruptcy; and
- Debt Management Plans.
Consumer Proposals
To put it in simple terms, a consumer proposal is a legal way to make a deal with your creditors. You can make this deal if you owe more money than you can afford to pay and want to avoid bankruptcy. You offer to pay them back over time and they get to vote on whether or not to accept your offer. It is uncommon that a deal cannot be negotiated. These are sometimes referred to incorrectly as a government debt relief program.
The consumer proposal is arguably the most effective form of debt consolidation, depending on your goals. It allows you to:
- Avoid bankruptcy;
- Reduce your monthly payments and/or debt load, often by up to 80%;
- Have no long-term consequences.
Despite popular belief, consumer proposals usually have the lowest monthly payments compared to other options. Read here to learn more about if a consumer proposal is worth it.
Bankruptcy
Bankruptcy is a legal process that allows you to get out of debt. Unlike a consumer proposal, creditors do not have the option to vote against your bankruptcy.
It is the most severe form of restructuring that most view as a last-resort option. However, it should not be dismissed as it is sometimes the best option to get out of debt.
Bankruptcy is based upon your household size, your household income, and realizable equity in your assets. Based on this, you will make a payment into your bankruptcy estate that may increase or decrease as your financial situation changes during the term of your bankruptcy. Once discharged, you will be released from your unsecured debts.
Debt Management Plans
A debt management plan is an agreement between you and your creditors to pay back 100% of what you owe over a period of time, usually 36-60 months. This is different from a consumer proposal or bankruptcy in that it does not involve any legal process and doesn’t involve any reduction of debt. However, it is a type of debt consolidation agreement that can sometimes be of assistance depending on your debt levels.
It is the closest option to a traditional debt consolidation loan. However, the credit impact of a debt management plan is the same as a consumer proposal. We see people turn to debt management plans when they are unable to qualify for a debt consolidation loan without understanding the true credit impact.
How to choose the best method of consolidation for your specific situation
Choosing the best option for your situation is highly dependent on your situation. We will break down just a few of the categories we look at when offering a free debt review.
Income
Understanding what your income will look like now and in the near future can drastically change the approach taken to deal with your debt.
The stability of your income also can be a critical factor in determining which option is best for you. Bankruptcies are more forgiving as it relates to decreases in income whereas proposals are more forgiving as it relates to increases in income.
Examples
If you know your income is going to drop in the near future you might:
- file a bankruptcy knowing your payments may decrease when your income drops, or;
- file a consumer proposal ensuring your Administrator takes the income decrease into account when computing the proposal payments so that you are not saddled with an unmanageable monthly payment when your income drops.
If you are a seasonal worker, keep in mind that if you file a bankruptcy, the trustee will be monitoring your income during the time you are bankrupt. Your income will be averaged over the term of the bankruptcy but if you have a considerable number of higher earning months during the period of bankruptcy, your bankruptcy payment may be higher; a consumer proposal can be structured to account for variations in income, for example, you could propose to pay a higher monthly payment when you are working and lower (or no) payments while you are off.
If you suspect your income will increase, you might want to file a consumer proposal over bankruptcy. There are a few reasons for this:
- if your income increases during bankruptcy, your payments may increase and your bankruptcy term may be extended and you may not know the exact total amount of your payments until the end of your bankruptcy, at which point you may need to make larger payments at the end of your bankruptcy in order to receive your discharge on time;
- your income is not monitored after a consumer proposal is accepted therefore your monthly payment, once accepted, will not change;
- you have the ability to apply extra payments to your consumer proposal payments to finish your proposal faster if your income increases.
If you are not sure which option to choose, but want certainty with respect to having a known monthly payment then a consumer proposal will provide that.
Disposable Cashflow
How much disposable cash flow you have plays an important role in any debt relief decision. Typically speaking, the higher your cash flow the easier it will be to implement various debt consolidation programs.
Generally speaking, debt management plans have the highest monthly payment of all the above-mentioned debt consolidation options.
Bankruptcy often has a lesser monthly payment, but despite popular belief can still be quite high.
Consumer proposals often have the lowest monthly payments because they are structured over 60 months.
The viability of some options such as the traditional debt consolidation loan rely heavily on disposable cash flow; you have to be certain that you will be able to make and maintain your payments as agreed. Unlike a consumer proposal or bankruptcy, if a consolidation loan payment is missed then that missed payment will be reported to both the Equifax and Transunion credit reports.
Asset Composition
The composition of your assets primarily impacts the options of a consumer proposal and bankruptcy. This is because some assets are unrealizable or exempt under provincial and federal laws.
For example, RRSPs are completely exempt in both a consumer proposal and bankruptcy except for the last 12 months of contributions (exemptions may differ by Province and we would be happy to discuss your specific situation with you).
Our understanding is debt management plans do not take into account assets.
Debt Composition
If you are looking to just consolidate credit card debt and other ‘normal’ unsecured debts such as personal loans and lines of credit then you have many debt consolidation options available to you, including the option of a debt consolidation loan (understanding the conditions we spoke about at the beginning of the article).
However, once you start having debts such as income tax arrears or student loan debt the options available to you start to lessen; especially if your credit is severely damaged.
Tips for staying on track with your debt consolidation plan
Whichever option you decide upon it is incredibly important to be diligent with managing your money. To help in your debt-free journey here are a few tips when consolidating when you already have poor credit.
A Budget Is A Must
No matter which debt consolidation program you choose and even if you choose to continue the course you are on all sound financial plans begin with a budget. Take an inventory of:
- What expenses you have;
- What income you make; and
- The goals you have.
With this information, develop a spending plan. Making a budget is not natural, nor is it easy. It takes time so do not beat yourself up if your budget doesn’t work out the first few months. Keep trying, make adjustments, and eventually you will nail down something that works for you and your family.
Don’t Forget About An Emergency Fund
We recommend that as soon as you enter into your chosen debt consolidation program that you begin building an emergency fund. We recommend aiming for a starting amount of $1,000 saved and then gradually work yourself up to having 3-6 months of bare-bones expenses saved up.
Forget About Your Credit Score
If you are struggling to pay back your debt, temporarily forget your credit score. Your credit score can always be rebuilt. We see it far too often that consumers avoid dealing with their debt and end up putting themselves in a far worse situation.
This can lead to applying for a debt consolidation loan that you may not be able to afford which just makes the situation worse.
Avoid Additional Credit Card Debt
Avoiding additional credit card debt is very important. The interest rates associated with credit cards are incredibly high. Some cards have an interest rate of 29.99%; especially those designed for individuals with poor credit.
While credit cards may seemingly have low monthly payments, this is usually due to them requiring interest-only (or near!) payments. While this might sound good at the time of purchase, remember that the minimum payments really start to add up. Your best bet is to save money and pay cash.
Try And Avoid Additional Debt Consolidation Loans
The debt consolidation loan rat race is real. Companies often make it seem like there is easy debt consolidation for Canadians. While this may be true sometimes, there are often negatives associates with it.
You get one debt consolidation loan, everything feels good, you loosen things up a bit, and realize months later you are in the exact same spot as you were before but with the old consolidation loan and the accounts you had previously consolidated racked up again.
Debt consolidation loans are great when they are properly planned for, but remember that in most instances the bank or lending institution’s job is to lend you money and oftentimes will not dig into your budget to ensure you can adequately afford it.
Conclusion
Every debt consolidation plan should first begin with a thorough, and most importantly, honest evaluation of your current financial state. With this, you can make a sound decision, which will be free from emotion which can sometimes cloud our better judgment.
If you are dealing with unmanageable debt and are considering a debt consolidation loan (or were denied debt consolidation loans) but are not 100% sure if it will help, do not hesitate to reach out. We’d be pleased to review your situation and provide you with guidance and debt consolidation advice.
This article was written by Angela Rodgers, CIRP, LIT. She is a Licensed Insolvency Trustee and the President of Powell Associates Ltd. She has worked in the insolvency industry for over 20 years. No matter if you are looking at filing bankruptcy, a consumer proposal, or simply looking for debt management advice, Angela can help.