“Debt Consolidation” in Canada

This rather broad term can mean many things depending on the situation, the person in question or what the desired outcome is. It also is often misused by people when they are referring to a financial course of action.

If you are struggling with multiple debt servicing payments per month (credit cards, retail cards, lines of credit, student loans, etc.), it may be you are looking to simplify your ongoing bill payments. Often, this will mean consolidating your payments in to one in order to reduce complexity and stress in your life.

Or you may be looking to be much more aggressive in tackling your debt – i.e., aiming to eliminate it once and for all so you can move on with your life.

Either way, information is good (knowledge is power), so let’s take a moment to review the various forms that debt consolidation can mean and what each can accomplish for you if you are in a tight financial situation. Pros and cons. Upside and downside.

Traditional Consolidation: A Loan

Normally, when one refers to ‘debt consolidation’, they are referring to a lending situation: you are borrowing a sum of money in order to pay off the total of your debts, thereby putting your debt into one loan/payment.

So in this situation you still have debt. You’ve just shifted it. Because any loan you take out (and they can take various forms: a 2^nd mortgage on your home, a secured line of credit, an often secured personal loan) will carry interest and you will have to pay back both principle and interest on some kind of terms. Regardless, you are still carrying the full debt – you are just paying it all to one lender. So you have simplified, but you have not REDUCED your debt.

That is the upside: the simplicity. For people who struggle with balancing bills with their income, this can be good. Budgeting is easier in theory because your expenses just got reduced.

Another pro of a consolidation loan is the interest rate is almost always lower – often significantly – than credit cards (and certainly retail cards). This means you can make some better progress in paying the loan down sooner than you would with the combined higher rates.

But you have not gotten any further ahead in debt reduction. That is a con.

The further and more serious downside? Most people who do a debt consolidation loan do not then cancel the original credit cards or lines of credit they had. Then temptation kicks in: our natural lack of fiscal discipline means we start using the cards again – perhaps just small purchase to start, maybe intending to pay those balances off. But then we don’t. And the interest kicks in and it is back into the credit card balance cycle again. So you also haven’t changed your habits.

‘Debt Consolidation’ via a Debt Settlement Program

A number of companies in Canada offer debt ‘consolidation’ services. This usually involves including certain of your debts into one single payment to their firm. This is not a loan situation; it is a negotiated payment plan with the creditors involved. But these companies have to be successful in negotiating with those creditors, and there is no guarantee the creditors will agree to it. Furthermore, there is nothing legally binding the creditors who agree to stand by the arrangement. You can expect to pay significant up-front fees, as well. And you will almost certainly end up paying a certain number of your debts which were left out of the deal. So your money will only be getting limited mileage, further reduced by the fees paid.

These are not licensed operators – they are merely companies which make promises of negotiation to which the creditors need not participate. So it is debt consolidation only for the creditors that they are able to get to agree to the deal. And often it is only for credit cards – not lines of credit (which are the fastest-growing unsecured debt vehicle in this era of low interest rates) or income tax owing, student loans, payday loans etc.

There are also debt settlement companies in Canada who offer to reduce your debt dramatically via a ‘new government program’ whereby you make a single monthly payment to all your unsecured creditors at a significantly reduced amount. Beware: they are referring to a consumer proposal.

In this case, the company is essentially acting as a referral source for you to a Licensed Insolvency Trustee (LIT), the only person who is able to file a Consumer Proposal. So you would be paying a fee to speak to a person to whom you could have otherwise spoken to or met with for free.

In 2015, the government of Ontario introduced a bill (C55) to deal with this kind of misleading practice to consumers .

Debt Consolidation with a Consumer Proposal

The most effective way of consolidating your debts (in terms of mileage) by far is via a Consumer Proposal. Also known as a Division 2 proposal, it is a widely used and growing alternative to filing bankruptcy. But often more importantly, a proposal is a great way to leverage limited cash-flow into actually eliminating your unsecured debt in a short timeframe.

A proposal allows you to make a single monthly payment with zero interest and usually at significantly reduced principal. Creditors will often agree to up to 80% reduction in principal owing. And interest is the real killer when it comes to credit cards with large balances. Just take a look at the “Estimated Time to Pay” statement on your credit card statement the next time you get one in the mail if you are carrying a balance. It can take DECADES to pay a large balance off at normal credit card interest rates unless you are making sizeable payments.

A proposal has a number of benefits in addition to allowing consolidation into a single low monthly payment:

• There is no loan – you are just making payments toward the elimination of your debts; so you are not just shifting debt
• Keep possession & control of all your assets, including your house
• No reporting of income – once the proposal is agreed to by the creditors, they cannot alter it
• Legally binding: there is a full legal release at the completion of the proposal
• Fully open terms: you can pay it off as soon as you are able with no penalties for doing so
• Maintain your freedom to buy & sell assets
• As mentioned above, 0% interest (all interest is stopped), so the debt doesn’t grow in the background while payments are being made
• All payments are made to a licensed trustee who must reconcile payments & provide full, regular reports of all dividends paid to the creditors
• Income taxes owing, HST, any director liability and student loans can be included the same as any other unsecured debt

A downside (if it may be called that) is that you will be required to give up your unsecured credit cards and lines of credit during the proposal, but that is in order to prevent you from incurring more debt as you deal with your existing debt. It’s a form of built-in discipline to truly get you debt-free.

It will also have an impact on your credit rating (an R7 for 3 years after completion on your credit bureau), but even then you are allowed a degree of control as you can accelerate the length of the proposal by paying it off sooner than the term with no penalty.

In short, a consumer proposal can be the most effective manner of debt consolidation, plus providing the assurance of being handled by a federally licensed Trustee.

If you have any questions or if you’d like more information about your own individual situation, you can speak to a licensed Trustee (LIT) for a free consultation. It never hurts to ask!