Comparing Your Debt Management Options
If the amount of debt that you’re carrying has become too large for your income, you may want to consider a consolidation loan or a consumer proposal. Both options can help manage your debts, but there are key differences you should understand.
Debt consolidation is often the first option that debtors consider, and it can be a way to reduce your monthly payments. If it’s done before your debts grow too large, lenders will be willing to refinance your high interest loans into lower interest consolidation loans.
Debt consolidation isn’t available or practical for every debtor, though. If your credit score is too low, you won’t qualify for refinancing. If your total debt has grown too large or your income is reduced, you may not be able to afford the monthly payments after refinancing.
A consumer proposal is like debt consolidation in the sense that you negotiate a settlement with your creditors to reduce your monthly payments. The important differences are that a consumer proposal reduces your outstanding debt, eliminates interest payments, and provides relief from collection efforts. You enter into a legal agreement that gives you the ability to repay a portion of your debts that you can afford.
Difference Between a Consumer Proposal and a Debt Consolidation Loan?
The difference between a consumer proposal and a consolidated loan is that a loan doesn’t reduce your total debt balance but instead reduces high interest rates and combines several smaller debts. A consumer proposal combines your unsecured debts into a single fixed monthly payment, but it also eliminates interest charges and reduces your outstanding principal by up to 75%. If you’re not sure which option is right for you, speak to a Licensed Insolvency Trustee to make the right decision for your financial situation.
When Does Debt Consolidation Make Sense?
Debt consolidation does have some advantages if you’re able to pay down your debts with a reduced interest rate. It can take different forms ranging from combining several high interest credit card accounts into a lower interest loan to a secured loan backed by real estate.
When evaluating a debt consolidation loan, you’ll need to honestly appraise your long-term income and financial situation. Questions to ask include:
- Can your debts be included in a consolidation loan?
- Do you have the credit rating or assets to secure a consolidation loan?
- Will the new loan’s monthly payments be affordable?
- How important will your credit rating be in the future?
Advantages of Debt Consolidation
There are important advantages to debt consolidation that make many debtors choose this option. The main reasons for pursuing a consolidation loan are that:
- You can secure consolidation loans with assets like real estate.
- You’ll pay the full amount of your debt balance.
- Your credit rating won’t be damaged by discharging debts.
- You’ll reduce the interest payments on your debt.
Disadvantages of Consolidation Loans
Debt consolidation may not solve your debt problem for several reasons. Consolidation loans allow you to keep credit cards and personal credit lines with high interest rates. If you continue using those high interest credit lines, you may end up growing your debt to unsustainable levels again.
Consolidation loans are sometimes offered on the condition that they be secured with a major asset or a co-signer. If you can’t make your monthly payments in the future, the assets can be seized or the payments collected from the co-signer.
Finally, if you enter into a debt consolidation agreement that isn’t affordable in the long term, you’ll only delay creditor collection efforts to a future time.
Debt Consolidation and Your Credit Rating
Debt consolidation doesn’t affect your credit rating substantially because the full amount of your debt is maintained. If payments are on time, your credit rating won’t be negatively affected, which is why many debtors opt for a consolidation loan if it’s available to them and they can afford the payments.
Eligibility for a Debt Consolidation Loan
Unfortunately, a debt consolidation loan is only offered on the terms that are acceptable to your creditors or a new lender. If you don’t meet the criteria that creditors use to manage their own risks, you won’t qualify for a consolidation loan. Generally speaking, consolidation is available to debtors who have good credit ratings, good income-to-debt ratios, valuable assets like real estate, or co-signers with sufficient income. If you don’t meet these conditions, creditors won’t be willing to offer you a sufficient loan with lower interest rates.
Consolidating Debts with a Consumer Proposal
A consumer proposal is another way to consolidate several unsecured debts into a single fixed monthly payment that’s affordable. In a consumer proposal, you negotiate a reduce total debt balance with your creditors and agree to make monthly payments on the remaining portion of it for up to five years.
Debt Relief Through a Consumer Proposal
Because debt consolidation focuses on combining many smaller loans into a larger loan and reducing interest rates, the loans included are typically credit card accounts, personal loans, and student loans. Secured loans are usually lower interest in the first place or too large to make consolidating them helpful.
What Debts Can a Consumer Proposal Consolidate?
Consumer proposals were created as a way for debtors with too much unsecured debt but who have enough income to pay back a portion of it. The types of debt that can be consolidated with a consumer proposal include credit cards, personal credit lines, student loans, and other obligations that are not secured with assets.
When Should You Consider a Consumer Proposal?
A consumer proposal will make better sense than debt consolidation if your income isn’t sufficient to pay back your entire debt balance plus interest. It may make more sense than bankruptcy if you have a stable income and want to avoid liquidation of your assets.
A consumer proposal might make more sense than a consolidated loan if:
- You have a stable income but find yourself insolvent and unable to pay all your debts in a reasonable time.
- Are insolvent or have too low a credit rating that a consolidated loan is not possible.
- You need to reduce your debt load.
- You want protection from wage garnishments, lawsuits, and other means of debt collection.
Advantages of a Consumer Proposal
The advantages of filing a consumer proposal include:
- Creditor protection
- Discharge of up to 75% of your total debt
- An interest-free repayment plan
- Keep your assets protected from liquidation
Disadvantages of a Consumer Proposal
A consumer proposal will only include unsecured debts like credit cards, personal loans, tax debts, and student loans (depending on their age). Mortgages and car loans are not included, for example.
A consumer proposal will affect your credit rating for several years because of the discharge of a portion of your debts. While it’s not as long-lasting as filing for bankruptcy, it will be damaged in the short term. You may find it difficult to obtain new loans without securing them with assets or co-signers until your credit rating recovers.
Filing a Consumer Proposal After a Consolidation Loan
It is possible to file a consumer proposal after getting a consolidation loan. Any unsecured loan such as credit card accounts,personal loans and tax debts will qualify for inclusion in a consumer proposal.