If you’ve considered the advantages of debt consolidation and believe that this may be the perfect debt relief option for you, it is now time to ask the most important question of all: Will I qualify for debt consolidation?

There is a degree of uncertainty when it comes to knowing whether or not you will be able to take out a debt consolidation loan. While even those with the worst credit will likely qualify for a program like debt settlement, the same individuals can find it hard, if not impossible, to qualify for debt consolidation. Three factors are taken into account when lenders are determining whether you qualify for a debt consolidation loan. Understanding them now can help you know whether or not you should pursue it.

Three factors that determine if you qualify for consolidation

Qualifying debts for a consolidation loan

Strictly, speaking, only unsecured debts can be consolidated using an unsecured debt consolidation loan. You generally cannot include debts that are secured with collateral. This would include:

    Mortgages
    Home equity lines of credit (HELOCs)
    Car loans

You can consolidate any unsecured debts that you have, which are any debts not secured with collateral. This includes:

    Credit cards
    Personal Lines of Credit (LOCs)
    Unsecured personal loans
    Back taxes
    Student loans

When you consolidate, you want to include as many of your existing accounts as possible. This will simplify your bill payment calendar. Instead of juggling multiple payments, you will only have one bill to pay each month.

What is your credit rating?

Getting a debt consolidation loan at the right interest rate requires good credit. If your credit has been negatively impacted by missed payments and collection accounts, you may have a difficult time qualifying for a loan.

In some cases, your credit score may be so low that you will not be able to find a lender that will approve you for the loan. In others, you may qualify for the loan, but only at a higher interest rate.

If the interest rate that you can qualify to receive is not significantly lower than the rates on your existing accounts, then consolidation will not be beneficial. You will not save any money by reducing interest charges and the monthly payment may be roughly the same. The interest rate must be lower than what you’re paying now for a consolidation loan to provide any benefit.

It’s important to keep in mind that lenders have different requirements that you must meet to qualify for a loan. Some lenders may provide approval for consumers with lower credit scores while some will have stricter requirements.
According to TransUnion, qualifying for any loan, even a mortgage that’s secured using the home as collateral, can be difficult if your credit score is lower than 600.[1] Unsecured loans tend to have higher score requirements because the lender does not have any collateral to use if you fail to repay the loan.

If your credit score is low, then debt consolidation may not be your best option to get out of debt. You may want to consider alternative solutions for debt relief.

Considering your debt service ratio

In evaluating your application for a debt consolidation loan, most lenders will take your debt service ratio into account. Your debt service ratio is the percentage of your monthly gross income required to make all of your minimum debt payments, including payments on unsecured consumer debts and secured debts such as a mortgage.

For example, if you gross $4,000 a month and must pay at least $1,500 a month to stay current on all your debts, then your debt service ratio is 37.5 percent.

Lenders have different maximum debt service ratio requirements for loans. Lenders will calculate your debt service ratio with the new loan payments factored in. If your ratio is too high, you may have trouble finding a lender willing to approve you.

Most experts recommend that your ratio should be no higher than 35 percent. You may be able to get approved with a higher ratio, depending on the lender. However, keep in mind that this means a higher percentage of your income would be required to cover your monthly debt payments. As a result, you may live paycheque-to-paycheque and have trouble making ends meet.

What if I don’t qualify for a debt consolidation loan?

Debt consolidation is not for everyone. In fact, many people who are looking for consolidation loans are beyond the point where a loan can help them. They may have too much debt to qualify, or their credit is too poor to receive a beneficial interest rate.

If you find that lenders aren’t willing to approve you, then you may need to consider other options. First, you should contact a credit counselling organization. They can evaluate your debts and budget to help you identify the best solution for your needs.

In many cases, they may recommend a debt management plan. This is a repayment plan that the credit counselling organization can help you arrange. It minimizes the interest applied to your balances and allows you to repay your debts with a single monthly payment, similar to consolidation.

This can be a good option for relief for people who can’t qualify to consolidate on their own. If you can afford to repay everything you owe, then working with a credit counsellor could be your best option.

If you cannot reasonably afford to repay everything you owe, even with reduced interest, then it may be time to consider more aggressive solutions. For example, you may want to consider debt settlement through a consumer proposal.

A Licensed Insolvency Trustee will review your finances and determine how much of your debt you can afford to pay back. They set up a 60-month repayment plan that pays back as much of your debt as possible. Then the remaining balances are discharged.

If the trustee reviews your finances and determines that you are insolvent, then they may recommend bankruptcy. This solution is not ideal, but it often provides the best opportunity to get a clean break with debt so you can finally recover from the hardship you’re facing.

Be realistic as you look for a solution

While most people would prefer to solve debt challenges on their own, it isn’t always feasible. Challenges with debt often have a negative impact on your credit and debt ratio, both of which can hinder your ability to qualify for a debt consolidation loan.

If you’re struggling to find a loan that can significantly lower the APR applied to your debt, then it may be time to explore other options. Debt.ca can connect you with a trained professional, who will evaluate your debt and budget, to help you identify the best solution for your needs.

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Sources:
[1] https://www.transunion.ca/mortgage