Since credit cards and other forms of consumer debt often have double-digit interest rates, 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 10 percent. Your bank or credit union may charge a 7% – 12% interest on debt consolidation loans. Other finance companies may charge 14% or more for secured loans, and up to over 30% for unsecured loans.

How much can you save with debt consolidation?

The average interest rate on credit cards in Canada is approximately 19%.[1] At that rate, a $10,000 debt could generate up over $6,200 in interest charges on a standard 2.5% minimum payment schedule. With some minimum payment schedules that only pay the interest plus 1% of the balance, the interest charges could add up to over $15,000.

Cutting the interest rate down to ten percent with a debt consolidation loan can help you save thousands. With a 60-month unsecured loan at 10% APR, you’d pay just over $2,700 in interest.

What’s more, you would pay off the debt faster and have slightly lower monthly payments.

As with other debt relief, a little education goes a long way. Learn how to pay off your debts, increase your credit score, and see improvements on your credit report.

There are many debt consolidation loans, and the way they calculate interest differs.

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 researching 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 the same 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 increases or decreases according to the rate change.

Both variable-rate and fixed-rate consolidation loans are available whether you negotiate a debt consolidation loan yourself.

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)

The equity in your home secures a HELOC and usually carries a variable interest rate. This is a revolving line of credit, which may not be available if you have poor credit history.

What is revolving credit?

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. If you make a $10,000 payment to 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 “finish” the loan.

Home Refinance Loan

Many people refinance their home and borrow more than they need so 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. However, 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 one of many unsecured loans. This means it is not secured by an asset. While many people have consumer loans that they must pay to avoid bankruptcy or a consumer proposal, a consumer loan may be a good consolidation loan for you if you qualify and 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 interest rates on debt consolidation loans 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 and add one or two percentage points to calculate your rate.

Consumer debt consolidation loans can follow the above mortgage loan patterns they have their own rules set by the bank. In any case, you generally pay a higher rate of interest if you have bad credit.

Asssessing the savings benefit of debt consolidation

Consolidating debt becomes less beneficial at higher interest rates. If you can qualify for a loan at 5% APR or even 10%, that offers significant savings. The total interest charges will be lower and the monthly payments may be lower as well. However, the higher the APR, the less beneficial that consolidation becomes.

This table shows the cost savings of debt consolidation loans at different interest rates, versus minimum credit card payments as well as the cost of making fixed payments on your credit card fro a $10,000 debt.

Repayment methodAPRMonthly paymentTotal interest charges
Credit card, minimum payments19%$408.33 to start$6,201.80
Credit card, fixed payments19%$410$2,737.96
Fixed-rate 24-month loan5% APR$438.71$529.13
Fixed-rate 36-month loan10% APR$322.67$1,616.19
Fixed-rate 60-month loan15% APR$237.90$4,273.96

Is a Debt Consolidation Loan Right for Me?

As you can see, when weighing the benefits of a debt consolidation loan, you need to consider the monthly cost savings as well as the total cost savings. Using a debt calculator can help you estimate how much you can save with different solutions. It can also be helpful to talk to a debt relief specialist, who can help you understand your options and find the best solution for your needs.

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Sources:
[1] https://www.4pillars.ca/blog/how-does-credit-card-interest-work-canada