What is debt consolidation?
Debt consolidation is the process of borrowing
money to repay your debts. The concept sounds strange
to most people. How can I borrow money to repay my
debts? What's the point?
It is true that initially debt consolidation does
not reduce the total amount you owe. You are simply
replacing a few debts with one larger debt. Here's
Example: Your total debt is $20,000 owing
to five different credit cards. The average interest
rate on your credit cards is 19% per year, so you
are paying almost $317 in interest every month on
your credit cards, and that does not include any repayments
of principal. You have a good job and good income,
so you go to your bank and negotiate a loan where
you pay the debt off over five years. Because it's
a loan and not a credit card, the bank charges you
an interest rate of 8%. Now your monthly interest
payments are less than $134 per month, and the interest
goes down each month because you are actually repaying
That's the power of a debt consolidation loan.
You borrow at a lower rate, to repay higher interest
If you own a home, the numbers are even better, because
with a home as security your interest rate may only
be, say, 6%. You save even more money. (Read our articles
on Getting a Mortgage to Pay off your Debts
and on Three ways to borrow against your house as a bankruptcy alternative).
When is a debt consolidation loan a good alternative
A debt consolidation loan is a good alternative to bankruptcy if you can afford it. Here's the process you should follow:
Start by researching your options. Sites such as www.debt-consolidation-loans-information.com provide useful information on debt consolidation loans
as a bankruptcy alternative. (They even have a free debt consolidation loan calculator to determine how much a debt consolidation loan will cost). A debt consolidation
loan makes sense if you have high interest rate
debts, such as credit cards and finance company loans,
and you have the ability to borrow at a lower rate.
To qualify for a debt consolidation loan the lender
will want proof that you have a good job with good
income to prove you can repay the loan.
A word of caution: Don't be tricked into getting
a high interest rate debt consolidation loan at a
finance company just because the monthly payment seems
lower. Some finance companies will take your 19% interest
credit cards and lend you money at 30% to pay them
off, but because they stretch your loan payments out
over 10 years, you are paying slightly less each month.
Don't fall for that trick. Over the ten year term
of the loan you will pay a huge amount; it's not worth
Debt consolidation loans are one of the best bankruptcy
alternatives for people with a good job who can
afford to repay their debts over a reasonable period
If you don't qualify for a debt consolidation loan, you may need to explore other options, such as a consumer proposal (if you live in Canada), or a Chapter 13 Wage Earner Plan (if you live in the United States).