Debt Consolidation can be a wonderful tool for paying down debt. While it doesn’t actually reduce your debt, it does reduce your monthly payments. In short, the money from your debt consolidation loan is used to pay off your multiple credit card balances or other loans. Once those multiple payments disappear you are left with one payment, the consolidation loan, usually at a lower interest rate, freeing up more discretionary income to put towards your monthly repayment . There are, however, some potential pitfalls that you should be aware of.
For one thing, you need to be careful your debt consolidation approach does not end up costing you more money in the long run. There may be pre-payment penalties and other closing costs and fees associated with refinancing your existing mortgage that would make a second mortgage or a HELOC a better option.
Even if you have a long-standing relationship with a bank, you might want to consider seeking help from a mortgage broker. They have access to multiple lending institutions, while your banker will be limited to whatever his or own bank offers. Mortgage brokers also have expertise in dealing with borrowers with less than perfect credit.
Without good credit, any debt consolidation approach using home equity it going to cost you more, and in some cases may exclude you entirely. It is important to consider the total cost of your approach before proceeding, even if you have good credit. Some Canadians opt for a mortgage with the longest repayment period to get the lowest monthly payment possible. In the end, they are likely to pay more in total than had they looked for other ways to reduce their debt.
If you owe more than you have in the equity in your home, you can still pursue debt consolidation through tapping into your equity to reduce the total you owe to levels that are more manageable.
Regardless of whether you can borrow enough to consolidate all your other debts or just enough to reduce them, there is a major disadvantage to refinancing your mortgage or taking out a second mortgage or getting a home equity line of credit.
Suppose you owe $40,000 to five different credit card companies and you refinance your existing mortgage and pay them off. You still owe the $40,000, only now you owe it to somebody else. What’s more, if your credit cards were “maxed out” or close to “maxed out,” you now have around $40,000 in newly available credit at your disposal.
Credit card spending is a major contributing factor to Canada bankruptcy. Can you resist the urge to start charging up those cards again? Some Canadians cannot, and find themselves within a few short years of refinancing their mortgages back where they started – with a mountain of credit card debt. Only now, they have no home equity to draw on and a Canada bankruptcy may very well be their only option for getting out of debt.
Using a debt consolidation loan to avoid a Canada bankruptcy is a sound choice for many Canadians who are willing to invest some time into formal credit counseling to help them learn to manage credit better in the future. Credit counseling is available from non-profit credit counselors and licensed bankruptcy trustees throughout Canada.