Since credit cards and other forms of consumer debt often have interest rates that are well into the double digits, it is little wonder that debt consolidation is such a popular debt relief option in Canada. Taking out a good debt consolidation loan can often save 5 percentage points or more on your debt interest payments. Depending on your credit history, your interest rate savings could even surpass ten percent. If your average interest rate on your consumer debt is 10 percent, cutting it down to 5 percent with a debt consolidation loan will cut your interest payments in half. You will also pay off your loan faster if you choose to make the same monthly payment after you take out a debt consolidation loan that you made before you consolidated your debt.
As with other debt relief options in Canada, a little education will help you better understand the nature of debt consolidation loans, and that will equip you to make a more informed choice regarding the best debt solution for you. There are several different types of debt consolidation loans, and the way the interest rate is calculated differs for each of them.
Fixed-Rate Vs. Variable-Rate Loans
You do not typically have to take loan rate types into account when you enroll in a debt settlement plan, but you need to know about them when you are looking into debt consolidation loans. You have two major options to choose from for consolidation loans: fixed-rate loans and variable-rate loans.
Fixed-rate loans have an interest rate that remains the same for the length of your loan term. No matter how market conditions fluctuate, your payment remains level because the interest rate never changes.
Variable-rate loans, on the other hand, have an interest rate that changes periodically. Every time the rate changes, your minimum loan payment will increase or decrease according to whether the rate increases or decreases.
Both variable-rate and fixed-rate consolidation loans are available whether you negotiate a debt consolidation loan yourself or you use the services of an experienced credit counselling service.
Debt Consolidation Loan Types
All debt consolidation loans have either a fixed rate of interest or a variable rate of interest, but there are still different types of loans, including:
• Home Equity Line of Credit (HELOC)—A HELOC is secured by the equity in your home and usually carries a variable interest rate. This is a revolving line of credit, and it many not be available to you if you have a poor credit history.
Revolving credit means once you pay down a portion of your loan, that amount is immediately available for you to borrow from again.
Scenario: You are approved for a $50,000 HELOC. You use $20,000 of that to pay off some consumer debt, leaving you with $30,000 in available credit. Say you make a $10,000 payment back into the HELOC. You now have $40,000 in available credit to use however you want.
Revolving credit differs from a traditional loan where you borrow once, repay the loan, and then the loan is finished.
• Home Refinance Loan—Many people refinance their home and borrow more than they actually need so that they can roll higher interest consumer debt into their less expensive mortgage. Refinance loans can have either a fixed or variable interest rate.
• Second Mortgage—With a second mortgage, you borrow against the value of your home but retain the initial mortgage. This leaves you with two mortgage payments each month, but it may be worth it if you can get a substantial interest reduction on the loan you use to pay off your consumer debt. The rate on a second mortgage can be fixed or variable.
• Consumer Loan—A consumer loan is a personal loan that is not secured by an asset. While many people have consumer loans that they must pay off in order to avoid bankruptcy or a consumer proposal, a consumer loan may be a good consolidation loan for you if you qualify and can get a good interest rate. Consumer loans can have a fixed rate of interest or a variable rate of interest.
How Are Debt Consolidation Loan Interest Rates Set?
You can predict how interest rates on debt consolidation loans are moving based on the prime interest rate and the bond market. When your consolidation loan is a mortgage product, banks set the variable rate by taking the prime interest rate and subtracting a few percentage points from it. Fixed-rate mortgage loans that you might get are set by the bond market. Banks take the going rate for bonds issued by the Government of Canada and add one or two percentage points to calculate your rate. Consumer debt consolidation loans may follow the pattern of the above mortgage loans, or they may have their own rules set by the bank. In any case, you will generally pay a higher rate of interest if you have bad credit than if your credit is sound.
Is a Debt Consolidation Loan Right for Me?
Ultimately, you should look into all of your debt relief options before you make a final decision about a consumer loan. Fill out the debt relief form to learn more about debt relief options.
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