How Does Debt Consolidation Work?

Canadians are often confused about debt consolidation, and while some of the methods out there seem like frauds, others can actually help you get your credit back on track. Essentially, debt consolidation occurs when a third party agrees to loan you the funds to cover your debts, allowing you to make one monthly payment over time.

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How It Works

In most cases, you will take out one large loan from a financier, and that financier doles the funds out to all of your creditors. Then, you repay those funds plus interest. Although it may sound expensive, the truth of the matter is that the interest rate provided to you by the debt consolidation lender is lower, which gives you a little advantage and allows you to save money over time. There are many benefits associated with debt consolidation, including:

  • The ability to make one payment each month. Depending on the terms of your loan, you can make one payment over the course of one or more years until you repay your debt.
  • A boost in your credit score. Because the debt consolidation lender repays all of your other creditors, your credit score may improve almost immediately.
  • The ability to use assets to secure your loan. If you own your home, you can put it up as collateral toward your loan and enjoy very low interest rates, even if you have less than perfect credit.

Applying for Debt Consolidation

If you have a lot of consumer debt, whether this means credit card debt, car loans, student loans, or any other series of debts that are difficult for you to repay, debt consolidation can help you. Many Canadians find themselves in over their heads, so to speak, and despite their timely monthly payments on things like credit cards, they are barely touching the principle balance and instead making payments only on interest. This is a fast track to nowhere; the debt will not resolve in such a manner. Debt consolidation repays high-interest debts immediately, so if you find yourself making only interest payments or drowning in more debt than you can handle, it is a good idea to apply for consolidation.

The Disadvantages of Debt Consolidation

Much like anything that involves finances, there are a few disadvantages associated with debt consolidation. These include the following:

  • You may lose your home if you do not make timely payments. If you put up your home for collateral and you default on your payments for any reason, your home is at risk.
  • The monthly payments may be high. This is especially true if you have a lot of debt or if you have many different creditors.
  • Your cosigner may be at risk. If someone else helped you obtain your loan due to your bad credit and you default on your payments, your cosigner's good credit is at risk.
  • You may still have access to credit cards. In many cases, the debt consolidation loan pays off your debt but does not cancel your cards. Thus, it is best to cancel your accounts or put them on hold until you have paid off your loan.

Debt consolidation is often not a scam, and for some people, it is an outstanding way to help them lessen the burden of their debts. It is not right for everyone, though. Consider your unique situation and whether or not you can afford the monthly loan payment before committing.

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