By Laura Morris
If you are like many Canadians, you may find it hard to save or invest money when there are credit card bills, car loans, and other debts to pay each month. Clayton Waite is a financial consultant with the Investors Group in Toronto and he says it's not uncommon for people to have a mortgage, car loan, one or two lines of credit and $10,000 in credit card debt. It's also not unusual for people to be making only minimum payments on the credit, cards. In these situations,Waite often recommends simplifying life and finances with debt consolidation.
"The whole premise behind debt consolidation is you're taking these credit facilities and combining them into one payment," Waite says. This accomplishes three things. First, you're reducing the interest rate across all your debt. Instead of paying 18 per cent interest on credit cards and maybe 7 per cent on a car loan, you pay one rate that can sometimes be as low as prime.
With one low interest rate, you also reduce your monthly payments. This frees up more cash for paying down debt, investing in your RRSPs, or even going on vacation. "The other thing it does is simplify your life. You're not having to worry about five payments anymore," says Waite "You're gaining control of your finances."
In fact, more Canadians have been opting for debt consolidation in recent years.
"The combination of record low interest rates and rising property values over the past few years has made these arrangements quite popular," adds Waite.
How do you consolidate debt?
There are two common ways to consolidate debt. The first is refinancing your mortgage and extending the amortization period. If you have 15 years left on your mortgage, you can push it back to 20 years. Then, your mortgage can assume your current debts including car loans, credit cards, and unsecured lines of credit.
This means all your debts are spread out over a 20-year period, explains Waite. Instead of having to pay your car loan within five years, you now have much longer. By securing these debts with your home, it also allows you to take advantage of lower mortgage interest rates. Finally, it's a structured payment plan that involves one simple mortgage payment per month.
A second option is a Home Equity Line of Credit (HELOC). With HELOC, you take out a line of credit that's secured against your home. This means can you attain credit based on the appraised value or purchase price of your home. The interest rate is a variable rate. So, Waite explains, this can be advantageous if you're not concerned with rates increasing.
Due to the fact that HELOC is a line of credit, you have flexibility in paying down the balance. It does require a fair amount of discipline, notes Waite, because it doesn't necessarily involve a structured payment plan. At the minimum, you're required to pay the interest on the line of credit every month.
By the same token, debt consolidation is not for everyone. For instance, it's not suggested unless you have job stability, along with a reasonable credit history, and you are committed to paying down the debt.
Remember, debt consolidation isn't a magical solution. It won't make the debt disappear. "The debt isn't going away. It's being restructured," says Waite "It's not going to do much good if they do a consolidation and then they run up their credit cards and max out their lines of credit." If you're not able to pay your refinanced mortgage or your HELOC payments, your home can be at risk. Waite says, "Unless people change their habits, they can end up in a worse situation."
For others, however debt consolidation can be beneficial. It can be used as a vehicle to simplify your life and finances.