51 – What Is Debt Consolidation & How Does It Work?

Wayne Kay  0:04  

Welcome to the Debt Matters podcast where we help Canadians find solutions to their debt with Licensed Insolvency Trustees from across Canada. I’m Wayne Kay. 

In today’s show, we’re going to talk about what debt consolidation is and how it works. We’re going to dive into why people do it and what the benefits are of doing a debt consolidation. What are some of the pitfalls that you really need to watch out for when it comes to this? And where, where’s the proper place? Because if you do this wrong, it could end up costing you a lot of money. So you have got to be right when it comes to making that decision. And what’s a good alternative to debt consolidation. 

These are some of the key points we’re going to be talking about today with Daniel Maksymchak from LCTaylor, Licensed Insolvency Trustee in Winnipeg and Kenora. Daniel, thanks for being here.  

 DANIEL MAKSYMCHAK

Wayne, nice to talk to you. Thanks for having me back.

Wayne Kay

Anytime we can help people out with their debt. I mean, it’s a great thing, isn’t it? 

DANIEL MAKSYMCHAK

It sure is. Yes, that’s why I come to work every day. 

Wayne Kay

Yeah, well, and there’s so many different ideas out there about debt. So it’s nice to hear from somebody who deals with this all the time. And today, we’re specifically going to be talking about debt consolidation. Because as I mentioned, in the introduction, if you do this wrong, it could actually be very harmful to you financially. So let’s start off with what debt consolidation is.

DANIEL MAKSYMCHAK  1:25  

Debt consolidation, in its simplest form, is really combining multiple debts into a single payment. So if you owe five different creditors $2,000 it makes $10,000 In total. That can be replaced by a single $10,000 loan. That would be consolidating your debt, for example. That’s the easiest way to understand it. And does this happen a lot? Do people consolidate loans?

People certainly try to. Typically, the easiest way to consolidate your debt, and something that’s been happening a lot recently – with the last few years of spiking house prices, is that people can borrow money from the equity of their house. They basically remortgage their house or get a home equity line of credit on their house. They withdraw that money and use that to pay their unsecured debts such as credit cards or unsecured lines of credit. 

And that’s effectively consolidating your debt because it is taking those multiple debts and combining it into a single debt, which is secured to your house. It is generally at a cheaper rate, because the house is collateral, there’s less risk to the lenders. So they’re willing to lend you that money at a cheaper rate, than the 20 to 30%, potentially that you’re paying on your credit cards.

Wayne Kay  2:38  

And I’m going to ask you, what are the benefits? And I think that was the key one, right there – saving of interest rate.

DANIEL MAKSYMCHAK  2:45  

Exactly that’s the key one. You can get a lower interest rate, which means that your payments go further, because more of it’s being applied to the principal, rather than the interest.

Another benefit and why people like it, even if the interest rate isn’t necessarily changing by that much is that it really simplifies your finances. So instead of having to worry about five different payments, with five different due dates, and five different amounts, you just have a single payment that you have to remember to only make. One payment once a month, and your debts are taken care of for that month.

Wayne Kay  3:15  

Okay, anything else we need to know regarding the benefits of this?

DANIEL MAKSYMCHAK  3:20  

Stress –  this simplification really leads to easing of the stress. You don’t have to worry about which one you’re going to pay, which one you have the money to pay. Either you have the money for this single payment or you don’t. 

Unfortunately, though, because of the house prices recently, in the increasing cost of living, debt consolidation has really become available to a segment of society that owns real estate, and not so much to the segment that doesn’t. They don’t have any assets to borrow against that are valued by the bank as being secure. 

So there’s been one group of people, people who own real estate who have been able to secure consolidation loans against that. But for people with no assets to secure it against, it’s quite tough to get a consolidation loan. Because if you think about it, if you’re a bank with no risk exposure to a certain person, and then they walk into your office and say, Hey, I owe all these other people money, will you give me a loan to pay them off? That bank is taking on all of the risk and the other lenders are getting off with full repayment. So it takes a lot of faith that the bank has in your ability to repay for them to want to step into the shoes of the other lenders with no asset to back the loan up.

Wayne Kay  4:35  

Yes, that’s a great point. So and I think, you know, we touched on on stress, but that really is one of the most important pieces. If you’re living a stressed out life because of all of these payments that you’ve got going on, that literally can affect your marriage, relationships, work, children, it can affect a lot of people.

DANIEL MAKSYMCHAK  4:58  

It sure can. Yes, it kind of consumes you, right? Because you know that if you’re not making these payments to these multiple creditors that you have, they’re going to be calling. They’re going to be looking for the money. And that’s another level of stress even beyond that. 

So anything that you can do to simplify your finances and make the payments easier to make, is going to not only benefit your wealth down the road, but also your happiness and satisfaction with life in the present.

Wayne Kay  5:23  

So what are some of the things we need to watch out for before we go and sign up for a debt consolidation loan?

DANIEL MAKSYMCHAK  5:30  

You really need to look out for the terms that are being offered to you in this consolidation loan. When you’re borrowing money from anyone, there’s a few key factors to review. The rate that you’re being offered in terms of interest. We talked about how it’s great if your consolidation loan is at a lower rate than the debt you’re already trying to pay. But if it’s at the same rate or higher, especially if it’s higher, it may be to your detriment to take out this loan. You’re going to get simplified as one payment – but if it’s at a higher rate, because you’ve had to go to a high risk lender,then it’s actually going to be harder to pay off the debts mathematically. 

Even though it may be centralized in one debt, the terms of the loan – how long are they giving you to pay off this loan, and what’s the payment going to be on it. Because if it’s a consolidation loan, that is over a short period of time, the payments might be so large that you’re not going to be able to make those payments compared to your credit card, where the minimum payment is manageable for you. Even if you’re not getting anywhere. That’s a problem. But cash flow wise, getting into a loan that you can’t afford to pay is just setting yourself up for failure as well. 

A third condition to watch out for is – that a lot of consolidation loans when you approach them for one, they’re going to maybe ask for a cosigner, somebody to sign that debt along with you. And when you get asked for a cosigner, you really have to realize that a cosigner is basically a co-payer. If you’re not paying the debt, they’re going to be expecting the co-payor, the cosigner, to pay all of the debt, not a certain percentage of it. They’re responsible for 100% of the debt if you can’t pay it. 

So if you’re going for this consolidation loan, because you might be having trouble paying your bills as they currently stand, it’s probably not wise to commit someone else to also paying those bills. That’s just bringing someone else into your problem.

Wayne Kay  7:28  

But probably they feel like there’s no way out. They don’t know about other options at that point. And so they go down to whatever, maybe they saw some ads on TV of some company that can help them out – and some of them can be ruthless.

DANIEL MAKSYMCHAK  7:46  

Yes, they see the person coming into their office looking for this loan as a high risk, and they charge high interest rates accordingly. They know that a certain number of these people are going to likely default on these loans. So they have to make enough money in interest from the others, to cover their losses on those. So getting a cosigner is a way to reduce the likelihood of someone defaulting because, of course, they’re going to have better luck trying to collect from two people than one person. Even if the other person is just as financially weak. They’re doubling their odds that they’re going to be able to get something from someone. So that’s the problem. 

They will say we have consolidation loans come in and borrow this money and we’ll set you up. But you know, you might not be getting ahead because your interest rate might be even higher, or, it’s not manageable, because the monthly payment that they’re looking for, it’s just too high.

Wayne Kay  8:41  

Let’s say there’s somebody listening who really isn’t up to date on what’s going on with interest rates. So when we say high interest rates, a lot of people maybe don’t even look at the interest rate that’s on a credit card, but that can be typically they start in the 19, 20, 21%. 

So then if you have a mortgage, well, that rate can be down to 2.5 percent, maybe less if they signed a couple of years ago. So we have a big swath there from 2.5 to 21% and over. So would you say the warning for people is stay away from anything over 21%?

DANIEL MAKSYMCHAK  9:20  

Well, it’s hard to put a fixed number on it, because it’s going to depend on what you’re currently already paying on your debt. If for some reason you were in a loan, a payday loan or something like that at 40%. You can go and get a consolidation loan even at 15 or 20%. Even though it’s a high interest rate, relatively speaking, it’s still quite low. It’s half as much as what you’re already paying. So that might turn the table so that it is now manageable for you. 

It’s hard to put kind of a fixed number to anything above this that you should avoid. I think it’s important when you’re evaluating whether you accept this consolidation if the loan is manageable. Is it going to really solve your debt problem? Because if it’s just moving debt from one pile to another, but you’re still not going to be able to pay it off anytime soon, that’s when you really want to look at other options besides just borrowing money to pay money and still ending up with the same amount of debt as well.

Wayne Kay  10:20  

And we’re going to talk about some of those alternatives coming up in just a bit. But first, I thought I would ask, where do you apply for debt consolidation?

DANIEL MAKSYMCHAK  10:30  

The most common place where people apply, and probably where they’re most likely to be accepted, is their existing bank or wherever they have currently, over the most money. Because as I said earlier, it’s unlikely or less likely that a bank that you have no prior experience with is going to lend you money to relieve the debts of other banks and institutions that you already owe the money to. 

If you already have most of your debt with a certain bank and you have a line of credit with them, you have a loan with them, and you have a credit card, or maybe even two credit cards with that bank, you owe them a certain amount of money. So if you’re going to consolidate with them, all they’re doing is really changing the form of the money that you owe them. They’re not taking on any additional risk. 

So those kinds of consolidation loans are more likely to happen because that bank is already exposed to the risk of you not repaying it. That’s probably where you would start for that reason. They know you best, so they’re going to have a better idea of whether you’re likely to repay them and honor the debt in full versus some new bank that you just walked into.

Wayne Kay  11:40  

Okay, good to know, that makes perfect sense. Let’s talk about the alternatives for debt consolidation. So you can’t get that loan from your bank. What do you do, then?

DANIEL MAKSYMCHAK  11:53  

If you can’t get the loan at all, or you can only get the loan at terms that aren’t wise to sign onto – either the interest rate is too high, or they’re seeking a cosigner, like we mentioned earlier. Then you need to look at other options, because your current debt load is not sustainable. Even if it was restructured through a consolidation loan. 

And that brings us to alternatives where you accept that the debt is just too high, you’re not going to be able to pay it off in full with the interest rates that they’re looking for. The only legal solution to deal with debt like that, in Canada is through a Bankruptcy or a Consumer Proposal. Those are things that can only be administered by a Licensed Insolvency Trustee. 

We get calls quite frequently from people who call and are looking to consolidate their debt. And we as well, have you talked to your bank or a lender who can lend you this money to consolidate the debt? Unfortunately, they haven’t been able to get the loan or not at terms that are acceptable to them. 

So what we can offer that is similar in some ways, is a Consumer Proposal which is similar to a consolidation in that all of your unsecured debt payments become combined into a single monthly payment that you have to make. And that payment is made to the Trustee. It simplifies your finances that way. But where it differs from a consolidation loan is that it’s not like the Trustee is writing a cheque to pay off all of your debts and you’re repaying the Trustee. Instead, the Trustee is negotiating a settlement effectively with your creditors to accept terms that are different than what you originally agreed to. So then you have one payment that you make to the Trustee who holds those funds in trust. 

Then those funds are distributed, prorated to the different creditors that you owe, according to the solution that you’ve negotiated with the Trustee. So there are some similarities to debt consolidation and that it’s a single payment that simplifies people’s finances, which is something they’re looking for. But unlike a debt consolidation, which is a loan to pay or other debts, because people aren’t being paid in full. It’s a different system.

Wayne Kay  14:02  

I think you’ve also mentioned something very important there. We talked about this all the time in the podcasts. We talk about when you deal with a Licensed Insolvency Trustee. They are regulated by the federal government and the first consultation is free. And so you mentioned that you get phone calls quite often people asking, what can I do? What should I do? And that’s a great place for many people to start, isn’t it?

DANIEL MAKSYMCHAK  14:30  

Absolutely. Licensed Insolvency Trustees, do free consultations. We can’t really take money until something has been filed. We offer free consultations. They call us, they ask a lot of financial questions, just because we’re known as the people who are regulated by the government and so called experts in this field. 

So we take those calls and some people, we just advise. Well, you have a house with a lot of equity in it, talk to your bank? Or if that’s not an option, then we can talk about Consumer Proposals and other alternatives like that.

Wayne Kay  15:07  

Yes. And how do they feel after those phone calls?

DANIEL MAKSYMCHAK  15:11  

The most common sentiment that we hear is just, relief. I didn’t know where to turn, so I call this number. I didn’t know what I would get out of this conversation. But I’m leaving this conversation feeling so much more relieved than I was when I made the call. So thank you for your time, thank you for relieving that stress and giving me these suggestions. 

And that provides job satisfaction to us, even if there’s no business derived from it. We make those calls and we’re happy to help because that’s part of this service that we provide as a Licensed Insolvency Trustee.

Wayne Kay  15:43  

It would sure be great if more people made these phone calls before they went and signed on the dotted line. So Daniel, what are some of your final words of advice regarding this topic? 

DANIEL MAKSYMCHAK

Again, we want to just remind people that it doesn’t really hurt if you’ve been to a bank, and you’ve talked about consolidation loans, and you just want to know if there’s any other options. It does not hurt to reach out to an LIT, a Licensed Insolvency Trustee. 

Wayne Kay

And Daniel, as always, thank you very much for all the help you’ve given us today and all the advice you’ve shared. Now let’s talk about that free consultation from Daniel Maksymchak or any of the Trustees at LCTaylor. You can go to the website there to get yourself a free consultation. Once again, LCTaylor.com. 

And that’s it for today’s Debt Matters podcast. Make sure you subscribe wherever you get your favorite podcast from. And of course for more information, you can always check out debtmatters.ca. Thanks for listening.