There are different ways that consumers can consolidate their debt. One is to take out debt consolidation loans.
A debt consolidation loan is a way to refinance debt. Consumers use debt consolidation loans to combine—i.e. consolidate—two or more individual debts into one, which they pay off each month, at a set—and in some cases lower—interest rate.
Who Issues Debt Consolidation Loans
Only certain lending institutions are authorized to issue debt consolidation loans: banks, finance companies, and credit unions. These institutions can offer loans that cover one of the two types of debt: secured and unsecured debt.
Secured debts are debts that are backed by collateral to reduce the risks of lending. Unsecured debts are funds that are not backed by collateral.
Secured debts include
- auto loans
- banks loans
- certain lines of credit
- certain credit cards.
Unsecured debts include
- credit card debt
- utility bills
- medical bills
- personal loans
- student debt.
Who Qualifies for Debt Consolidation Loans?
If you’re still asking yourself, what is a debt consolidation loan? it’s important to know that not everyone qualifies, especially those who have bad credit. Another factor that may disqualify consumers from receiving debt consolidation loans is a high debt-service coverage ratio. (A debt-service coverage ratio is the percentage of a consumer’s monthly gross income needed to fulfill their minimum debt payments.)
For these consumers, enrolling in a debt consolidation program at a non-profit credit counselling agency may provide them a better way to pay off two or more of their unsecured debts by consolidating these debts into one debt that consumers pay off on a monthly basis.
When consumers pay off their unsecured debt through a debt consolidation program (DCP), they work with certified credit counselors who negotiate on the consumers’ behalf with their creditors to lower or even eliminate the interest rate on their unsecured debts.
When a debtor works with a credit counsellor, the first thing the counsellor will do is provide a non-judgmental assessment of the debtor’s financial situation. They will assess
- Debts: interest rates, debt and credit card balances, and minimum payments
- Assets: the value of a home, RRSP/RESP, car, other properties, etc.
- Expenses: monthly cost of necessities like utilities and food
- Income: net pay (even if consumer’s have no income)
- Life and financial goals
Debt Consolidation Loans Are Not for Everyone
Debt consolidation loans come with their own pros and cons. Whether the pros will outweigh the cons depends on a number of factors, including your personal goals, financial goals, and spending habits.
If debt consolidation loans aren’t right for you, that’s okay: there are alternatives. A debt consolidation program, for instance, may be the better way to go.