When it comes to managing debt, less is more. Which is to say, making a single on-time payment each month is often easier than trying to keep track of many different payments. And depending on the interest rates you’re being charged, it may be cheaper too.
The process through which several small debts become one larger debt is called consolidation, and there are a couple of different ways you can achieve it. Debt consolidation loans and personal loans are a couple of popular methods.
What is a debt consolidation loan?
A debt consolidation loan is a type of personal loan that has been specifically designed to combine various debts into one.
Typically, debt consolidation loans are used when you have multiple, high-interest, unsecured debts such as credit card debt.
Once approved for a debt consolidation loan, your lender will provide you with the money to pay off all your other debts so you are left with a single, larger loan.
The main draw of a debt consolidation loan is that it typically offers lower interest rates than credit cards or other lines of credit.
Depending on your personal financial situation, you may require collateral (ie: your home or car) to be approved for a debt consolidation loan, however.
What is a personal loan?
A personal loan allows you to borrow a fixed amount in the form of a lump sum, but it has no predetermined use. Personal loans can be secured or unsecured.
You can use the money obtained from a personal loan for pretty much anything you want. Common uses for a personal loan include home repairs, buying a car, or financing a big purchase, like a wedding.
Like a debt consolidation loan, personal loans can also be used to pay off other debts, though the limits and shorter terms offered by personal loans might be a problem if you’re trying to manage more than $50,000 of debt.
Debt consolidation loans vs personal loans
|Debt consolidation loan||Personal loan|
|Common uses||To pay off high-interest debts.||Home renovations.
High-dollar purchase (car, appliances, etc).
Expensive life events (wedding or funeral).
To pay off high-interest debts.
|Where to get||Banks|
Private or alternative lenders
Private or alternative lenders
|Typical loan limit||$50,000 to 100,000, depending on lender||Up to $50,000, depending on lender|
|Typical interest rate||Ranges from 6% to 32.00% APR, depending on credit profile.||Average rate is around 10%, depending on credit profile.|
|Typical qualification requirements||
Debt consolidation loan vs personal loan: Which is right for you?
A debt consolidation loan is a type of personal loan, but not all personal loans are debt consolidation loans. Debt consolidation loans share many characteristics, but may vary on qualification requirements, collateral requirements, interest rate and loan limit.
The loan option that’s right for you will depend on what you’re hoping to accomplish with the loan, and your credit profile. For example:
- If you’re looking to finance a purchase that’s under $50,000 and you have a good credit score, a personal loan may be the right choice.
- If you’re looking to consolidate a large amount of high-interest debt and you have a lower credit score, a debt consolidation loan might be the right choice.
While shopping around be sure to ask potential lenders the following questions:
- What is the best interest rate you can offer me?
- What additional fees do you charge?
- What will the monthly payments be?
- How long will I have to pay this loan back?
- Will I face penalties if I repay the loan early?
Whatever method you use to consolidate your debt, be sure to compare interest rates and fees from several lenders. The interest rate you are paying on your single loan should be less than the interest rates of the debts you are consolidating. If not, you may not actually save money by consolidating.
However, this can be difficult as oftentimes those who need to consolidate their debt have been struggling for a while and have low credit scores. A lower score can make it harder to get approved for competitive interest rates.
Alternative financing options to consider
If you do not qualify for a personal loan or a debt consolidation loan there are a couple of other options you can consider. If you haven’t yet, you can go to an alternative lender. However, these lenders typically have higher interest rates which may defeat the purpose of consolidating your debt.
Other options include:
- Low-interest credit cards.
- Balance transfer credit cards.
- Home equity loan or home equity line of credit.
- Consumer proposal.
Common loan types include personal loans, home loans and student loans. Knowing how different types of loans work in Canada can help you choose the right option for your goals.
The MyMoney Loan offers up to $30,000 in financing with a max of seven years for repayment, but be sure you account for high interest rates before applying.
A car loan is a way to purchase a new or used vehicle when you lack the cash to buy it outright. Car loans are available from banks and credit unions, as well as online lenders.