Debt Forgiveness vs
Consolidation Loans 

Debt Forgiveness vs Consolidation Loans in Canada

Ever wondered what the difference is between a consolidation loan and debt forgiveness?  Never even heard of debt forgiveness?  Is it all as clear as mud?  Well, you’ve come to the right place then.  Financial topics can feel intimidating and difficult to navigate and the way major financial institutions define things can sometimes leave us even more confused.  Let’s tackle two financial concepts today: consolidation loans and debt forgiveness.

What is a debt consolidation loan?

A consolidation loan is a loan or line of credit that takes other loans, credit cards and debts and rolls them into one payment.  Essentially, it is borrowing money to pay off borrowed money.  With one consolidation loan, you have a set interest rate and one payment rather than several payments to several debts with various interest rates.  In most cases you can keep your old credit or debts.  In some cases, you will be required to close access to the old credit cards and debts.

Not all consolidation loans offer a better or lower interest rate.  There are high interest rate lenders that specifically target people that may have bruised credit in the past.  If you have been late on your debt payments in the past or your debts are in collections at the time you are searching for a solution, a high interest consolidation loan may seem like the only option. 

When you consolidate your debts, you are paying off the full amount plus interest. In order to qualify for consolidation loan, the lender will check your credit and want to know your income, expenses, assets and liabilities in order to assess the risk of lending money to you to pay off your other debts.  Once you are approved, you are bound by your contract with the lender to make your payments including interest and hopefully pay it off in full at some point.

With a debt consolidation loan, you are not required to work on your money mindset or behaviours and change your money habits.  The responsibility is really on you to avoid getting further into debt in the future.

Types of credit you can include in your consolidation loan

With major banks and financial institutions, you can usually consolidate most credit card balances and lines of credit.  Student loan debt and other loans can sometimes be a little tricky, but some lenders can consolidate them as well.  

Impact on credit report

The consolidation loan provider will check your credit, so there will be an additional inquiry on your credit report which, may impact your score.  The number of inquiries on your credit report have a 10% impact on your overall score.  The consolidation loan will be visible on your credit report and making your monthly payments on time will be crucial.  Your score may drop initially as you will have a high balance on a new loan.  As you pay it down your debt, your credit score will improve. 

Pros of Debt Consolidation Loans:

- good for highly disciplined people that will not rack up the old credit again
- may be good as part of an overall financial plan through a financial expert
- one-time option for taking advantage of a much lower interest rate and accelerating payments
- short-term impact to credit report
- has potential to reduce your interest and assist to manage one payment instead of multi payments each month

Cons of Debt Consolidation Loans:

-not good for individuals who lack discipline not to use the old credit again
-short-term relief from overwhelming and unmanageable debt rather than a permanent solution
-not ideal for someone struggling to keep up with the new consolidated payment

Watch out for upfront fees, high interest rates and be sure to select a reputable company by checking them out on Better Business Bureau, reading reviews and running it past your accredited and licensed financial professional.

What is debt forgiveness?

Having your lenders forgive the debt you owe them or a portion of it, is debt forgiveness.  There are two debt forgiveness programs in Canada: Consumer Proposals and Bankruptcies.  Both are only available through federally regulated Licensed Insolvency Trustees.

In a debt forgiveness program, you only pay back a portion of your debts not 100%. There is zero interest.  It is one monthly payment based on your budget and federal guidelines.  It is not a loan or a form of additional credit.  In order to qualify for one of the debt forgiveness programs, you will have a consultation with the Licensed Insolvency Trustee firm, to gather information such as your income, expenses, assets and liabilities.  Student loans*, Canada Revenue Agency debt and all unsecured debt can be included in a debt forgiveness program.

As part of the regulation, you will be required to attend two mandatory counselling sessions to help with money mindset and behaviours.  You will be required to change some of your money habits and build new ones to help you avoid becoming overwhelmed by debt in the future.  Your old credit cards, loans and other unsecured debts will be closed out. 

Impact on credit

A consumer proposal shows as an R7 on your credit report and remains for 3 years after completion to a maximum of 6 years.  Bankruptcy shows as an R9 on your credit report and remains for 6 years after you are discharged from bankruptcy. 

Credit game chart

Pros of debt forgiveness:

-you only have to pay back a portion of what you owe rather than the full amount
-it can help you free up cashflow each month
-zero interest and one payment per month rather than multiple
-it is legally binding on creditors for your protection
-can provide immediate relief of creditor calls
-good for individuals wanting to get out of the credit loop - borrowing to pay off borrowing

Cons of debt forgiveness:

-impact on credit report
-may make it difficult to qualify for additional credit at best rates and terms in the short-term
-not good for those who are comfortably paying their debts monthly as they come due

Watch for up-front fees, high interest rates and be sure to select a reputable company by checking them out on Better Business Bureau, reading reviews and running it past your accredited and licensed financial professional.

The biggest question is “Am I managing my debt payments as they come due?”  If not, then you need to look at both options, be real about your strengths and weaknesses and choose the solution that has the best chance of being sustainable.  Discuss your options with a Licensed Insolvency Trustee firm like Bromwich+Smith and do not sign into a program or loan in a rush, without ensuring the company you are working with is reputable.  

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