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Regardless of economic or educational background, living above our means has become all too common. In fact, the current household debt-to-income (DTI) ratio in Canada is up nearly 25% from just one decade ago. Some of the most common reasons for debt include job loss, health issues, student loans, child rearing costs, or simply not understanding the fine print on credit card agreements. Unfortunately, once someone has found themselves in a financial hole, it can be nearly impossible to climb out without help.

Debt consolidation may be the answer! 

Debt Consolidation Redefined

When you’re in debt, the combination of overdue bills, debt collection calls, and financial arguments with a spouse or partner can leave you physically and mentally drained. In fact, studies have shown that stress caused by debt can have serious health consequences, including depression, anxiety, high blood pressure, and even stroke.

If you’re feeling stressed over money issues, debt consolidation is a great option that can take a lot of the pressure off of you.

Debt Consolidation in Action

In a nutshell, debt consolidation is the process of combining two or more debts into one; it doesn’t eliminate your debt, but rather wraps them up into a single monthly payment, making it easier for you to manage.

The first step to debt consolidation is meeting with a certified credit counsellor (preferably one who works for a non-profit credit counselling agency). They will be doing a lot of the heavy lifting for you, and their first task is reviewing your monthly income and expenses to determine if debt consolidation is the right fit for you. If so, your dedicated credit counsellor will negotiate with your creditors to either stop or significantly reduce the interest on your debt, giving you a bit of breathing room. This will also help you start to actually pay down your debt, rather than just the interest.

Your counsellor will set up:

  • One monthly payment—you send your payment to the credit counselling agency, and then they disperse it to all your creditors.
  • A lower monthly payment—that works with your budget and monthly expenses.
  • Lower interest rates—in most cases, zero percent!
  • An end date—many individuals complete their program in as few as 36 months.

Benefits of Debt Consolidation

The benefits of debt consolidation go beyond easing your monthly payments. Your credit counsellor will also work with you to set financial goals and help you develop money management skills that will help you achieve them. This is accomplished in three ways:

  • Expense tracking. Seeing exactly where your money goes each month will help you understand where you spend the most, and where you can cut back to save.
  • Budget building. Developing and adhering to a budget will help you grow your savings and build an emergency fund so you don’t turn to credit cards every time the unexpected happens.
  • Set financial goals. Whether you want to save for a downpayment on a home, your child’s education, or your own retirement, your counsellor can offer advice, from investing to picking up a side gig.

Related: Borrowell – Free Credit Scores and Low Rate Personal Loans

Bankruptcy: A Last Resort

Bankruptcy is sometimes thought of as offering a “fresh start.” But that’s not how it works at all. Rather than wipe away your woes, bankruptcy continues to follow you for years to come:

  • It destroys credit and makes it very hard to re-establish
  • It confiscates non-exempt assets, including RRSP contributions, HST cheques, and current or future tax refunds
  • It seizes any home equity; if you don’t own a home, getting a mortgage later will be next to impossible

In addition, you may still have to make some payments based on your income; plus, you’ll be required by court to attend counselling, as well as report income and taxes for years to come.

The Difference Between Programs and Loans

A Debt Consolidation Program (DCP) is essentially an arrangement where a credit counsellor works with your creditors to combine your debts and reduce your monthly payments. The debts don’t immediately disappear but rather are paid off over time—usually within 36 to 48 months—and no additional debt is incurred. (Bonus!)

A debt consolidation loan, however, does involve taking out another loan to pay off your debts. Now, instead of paying back various debts to multiple creditors, you make one payment on one large loan to the lending institution that gave you the loan. But to qualify for this loan, you must have good credit. Unfortunately, most people who want or need a debt consolidation loan don’t have good credit, which is why most are rejected. And to add insult to injury, they’ll take another hit on your credit score because they attempted to get additional credit, which meant another hard inquiry by a creditor on their credit report.

There’s another reason to consider a program versus a loan: It’s too easy to fall into debt again with a debt consolidation loan. Because the loan was used to pay off all of your account balances, you now have zero balances on all the accounts. For many people on a tight budget, the temptation to continue to use these accounts can be too great, resulting in further financial difficulties—so now you have additional debt to take care of on top of that enormous debt consolidation loan you took out.

Unsecured vs Secured Debts

Debt consolidation combines unsecured debts, which includes credit cards, some lines of credit, utility bills, medical bills, and payday loans. These debts are considered unsecured debt because they aren’t backed by an asset. Creditors might take you to court if they’re not repaid, but there’s no property they can seize, such as a car or a home. (That’s why auto and home loans are considered secured debt.)

Even though a DCP can’t help directly with your secured debt, by making your unsecured debt more manageable, your secured debt will become more manageable too.

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Picking the right agency for Debt Consolidation

People in debt can be desperate for help, and this can make them more vulnerable to scams. Be sure to do your due diligence before signing onto a DCP. Here are five things you can check on before signing the dotted line:

1. Fees

Good credit counselling agencies want to help you, and therefore don’t charge much. Counselling should be free, and programs should not have more than an initial set-up fee (usually $50) followed by a small management fee deducted from your monthly payment.

2. Non-profit organization (NPO) or charity status

Check a company’s status to make sure they are a non-profit organization (NPO) because they have nothing to gain by taking advantage of you. You can also check to see if the NPO is a registered charity through the Government of Canada’s charity search tool. (A good agency will be a non-profit, but a great agency will be both!)

3. Accreditations

Non-profit credit counselling agencies must adhere to strict industry standards, and their counsellors must go through stringent training to receive accreditation. Two accreditations to look for include the Association for Financial Counselling & Planning Education (AFCPE) and Credit Counselling Canada (CCC).

4. Better Business Bureau (BBB) rating

The BBB rates organizations on a school grading system (A+ to F) based on complaints from the public and numerous other factors. You’ll also want to check if the agency has received the BBB Accreditation Seal, which will appear at the top of their BBB profile.

 5. Google Reviews

Read what you can from others who’ve worked with the agency. A quick online search can turn up consumer complaints or accolades. In addition, you may find that the agency has been featured in reputable publications; that’s generally a good sign that they can be trusted.

Debt Consolidation and Your Credit Score

Most people entering a debt consolidation program or DCP already have a poor credit rating and score. (Most people who have poor credit have have significant debt issues which need to be addressed.) While debt consolidation may temporarily hinder your credit, it actually puts you on the fast track to improving it because it eliminates your debt.

Some of the most common factors contributing to a poor score, which can be corrected through a debt consolidation program, are as follows:

  1. Payment history. Most people seeking debt relief have accounts in collections or accounts with missed or late payments. This stops immediately once you sign onto a DCP.
  2. Credit utilization. Otherwise known as available credit versus credit used. Maintaining a good score means keeping this figure at or below 30 percent; however, most people in debt-distress are already over, at, or near their credit limit. A DCP puts a pause on your credit utilization, giving you (and your credit) time to recover.
  3. Inquiries. This is the number of times you’ve applied for credit; when people are in financial trouble, they often make the mistake of trying to get more credit. When you’re on a DCP all credit inquiries stop.

Related: 10 Strategies To Improve Your Credit Score

Debt Consolidation Programs and Credit Cards

Entering into a debt consolidation program does require relinquishing your credit cards, but only temporarily. The reality is that most people’s cards are maxed out at this point anyway, so having a credit card is useless.

Most people today don’t carry cash or cheques, so instead you can use a prepaid or secured credit card while you’re on the program. You simply load the card with your own money and use it like a regular credit card. Then when it’s out of money you simply reload the card. The best part about using a prepaid or secured credit card is that you won’t have to  worry about overdraft or late fees.

Once you’ve completed your Debt Consolidation Program, your credit will start to improve and you’ll have learned valuable money management skills that will help you achieve whatever financial goals you make in the future. And when you decide to try credit cards again, you’ll know exactly how to use them to your advantage.

Get the Help You Need Now

Ready to see how much you can save and how quickly you can be debt-free with a Debt Consolidation Program? Just answer a couple questions about your credit situation and Credit Canada’s Debt Calculator will give your results instantly. Then you can start thinking about what you’ll do with your savings, whether it’s a short-term goal, like a vacation or long-term goal, like retirement. Either way, you’ll be able to stop the bills, end the collection calls, and rest easier!

This post was contributed as a guest post by Credit Canada – a non-profit charity that provides free credit counselling and debt consolidation services to Canadians.