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Debt Consolidation Loans: The Hidden Trap

By J. Douglas Hoyes, CA, Trustee

A significant number of the people who call our 310-PLAN information line, or who complete our free bankruptcy evaluation questionnaire or who e-mail Hoyes Michalos with questions, are asking a simple question: How can I get a debt consolidation loan? The concept behind a debt consolidation loan is simple: you get a loan at a low interest rate and use the money to pay off all of your high interest rate debts, like credit cards. Sounds like a plan, right?

Yes, if you have good credit, and the ability to repay the loan, a debt consolidation loan may be a good idea. Unfortunately if you have a lot of debt, you may not qualify for a debt consolidation loan. Or you may qualify, but only with a co-signer, which means someone else is now liable for the loan if you don’t pay. With a slow economy everyone’s job is at risk, and if you lose your job you may not be able to repay the loan, so it’s very risky asking a family member or friend to co-sign on your behalf.

There is, however, an even bigger problem with debt consolidation loans: A debt consolidation loan does not reduce your total debt. If you owe $50,000 on five credit cards it’s great to replace those five monthly payments with only one payment on a loan, but you still owe $50,000! Your total debt level remains unchanged. Lowering the interest payment is great, but unless that frees up enough cash to allow you to repay the loan in a reasonable period of time, you may not be better off; you may simply be trading one debt for another.

What should you do? Start with some research. There are many great resources on the internet, such as this debt options calculator (it’s free, and takes less than 30 seconds to complete). Other debt consolidation loans information resources can help you assess your options. We have an article discussing the advantages and disadvantages of a debt consolidation loan. Talk to your bank to see whether or not you qualify for a loan.

If you don’t, or if the monthly payments would be more than you can afford, it’s time to look at other options. For many people a consumer proposal is the perfect alternative to a debt consolidation loan. Like a loan, you make one monthly payment, but unlike a loan there is no interest, and it is often possible to negotiate a settlement with your creditors where you pay less than the full amount owing. Paying $1,000 per month on a debt consolidation loan may not be possible, but paying $500 per month may be possible in a consumer proposal.

Of course that’s just an example; the actual amount the creditors would accept may be higher or lower in your case. A consumer proposal is not right for everyone, but to find out if it’s the right solution for you please call us 310-PLAN (no area code required), or e-mail us today and we will review your situation and help you decide whether a debt consolidation loan, a consumer proposal, or some other solution is right for you.

Full post as published by Hoyes Michalos and Associates Ontario Personal Bankruptcy Blog on April 20, 2009 (boomark / email).