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How to Consolidate Credit Card Debt

Canadians have some of the most debt in the world, especially when compared to other developed nations. Most of this debt is in mortgages because of high home prices and the high rate of homeownership in Canada, but a sizable portion is in credit card debt.

 

The average Canadian that is carrying a balance has $8,600 in credit card debt. That’s enough for a full semester at university or a new (used) car, and it’s instead collecting expensive credit card interest. And credit card debit is expensive! You can expect an average interest rate of at least 19.99% for most rewards credit cards in Canada. A balance of $8,600 costs around $143 a MONTH in interest. That’s over $1,700 a year!

As you can see, this isn’t a small amount of money we’re talking about. Although the minimum payment on your credit card is just a small portion of the total balance, it can cost you a lot more than the initial purchase price.

It’s in your best interest to cut your credit card debt as quickly as possible, but you probably don’t have several thousands of dollars laying around – otherwise you wouldn’t be in debt! The next best step to getting out of credit card debt is to do some form of credit card debt consolidation, whether that’s getting a balance transfer credit card, personal loan, or home equity loan.

We’ll examine the benefits and drawbacks of each of these options so you can make an informed decision about which debt consolidation method is right for you.

 

1.     Balance Transfer Credit Cards

One of the best ways to deal with credit card debt is to get another credit card.

It’s strange, but true!

Certain credit cards offer what’s known as a “balance transfer promotion,” which can be as low as 0%! Now that $8,600 goes from costing you $143/month to costing you $0 per month, allowing you to rapidly accelerate your debt payoff.

However, this method isn’t without its drawbacks. In fact, it could be one of the riskier ways to consolidate your credit card debt, so be careful.

Before we get into the downsides, let’s look at the positives. Balance transfer credit cards are so good because:

·        They offer interest rates as low as 0%, which greatly reduces the cost of your credit card debt

·        The interest rate on balance transfer credit cards is almost always lower than getting a loan or line of credit

·        You can keep the credit card after you’ve paid it off, which improves your overall credit utilization ratio

·        You can combine debt from multiple different sources onto 1 card, if your limit is high enough

The biggest upside to balance transfer credit cards is the amount of money you can save. Going from owing $143 per month to owing $0 is amazing, but even if your debt is smaller you can still save a good amount of money.

But balance transfer cards have their own unique set of problems. For one, you need good to excellent credit to even get approved for one (think 720 or higher). You may get approved at lower credit scores with good income, but it’s best to have high credit.

That can be a dealbreaker if your credit card debt has caused your credit score to go down. Paradoxically, the reason you want to get a balance transfer card (to get out of debt) may be impossible to get because of the reason you want to get it.

It’s best to apply for a balance transfer card as soon as you’ll think you need it. Not only will you start saving money immediately, but you won’t risk having your score go down as a result of having too much interest to keep up with.

But remember, missing a payment on your balance transfer credit card is worse than missing a payment on your regular card. If you miss a payment, your interest rate will automatically shoot back up to the card’s non-promotional rate (which could be even higher than your old interest rate!) and you’ll still be on the hook for the balance transfer fee.

While your minimum monthly payment after transferring a balance can be as low as $10/month, you should always pay as much as possible. Balance transfer promotions don’t tend to last very long in Canada when compared to American cards. On average, you can expect a low rate for between 6 months to a year. You should use that time to pay down as much as possible so that, even if you can’t pay it all off, by the time your rate goes back up your debt will be much lower than what it was.

Here are the downsides to balance transfer credit cards:

·        Require a good credit score

·        Charge a balance transfer fee which can be as high as 3% of the balance transferred

·        Can tempt the cardholder into further spending

·        Shouldn’t be used while there’s a balance on it

If you want more detail about the pros and cons of balance transfer credit cards, read our ultimate guide to balance transfer credit cards here.

 

1.     Home equity loan/Line of credit

Consolidating your debt with a home equity loan or line of credit is one of the most popular ways to consolidate. After all, many Canadians are homeowners with equity in their property, and qualifying for a home equity loan is often easier than applying for a personal loan. There’s also the added benefit of lower interest rates than unsecured loans. The interest rates won’t be quite as low as a balance transfer credit card, but can be a good option if you have bad credit or a large amount of debt.

Using your home’s equity can make it easy to be approved for a loan for tens or even hundreds of thousands of dollars, allowing you to consolidate not only your credit card debt, but any high interest debt. You might not want to consolidate low interest debt like OSAP or a car loan depending on your interest rate and repayment plans, because they have lower interest rates or favourable repayment terms.

The benefits of home equity loans are:

·        Easy approvals even with bruised credit

·        Lower interest rates than unsecured loans

·        Can borrow a lot of money very cheaply

Home equity lines of credit are a little bit different than loans, because you don’t need to use all of it. You only use what you need to use, whether that’s $10,000 or $100,000. You’re only charged interest on the portion you use, so if you don’t need a lot of money using a HELOC is a great way to save money.

HELOCs are interest-only products, so you only have to pay interest every month. You won’t get out of debt that way, but it cuts your monthly payment in half. It can be cheap to make interest-only payments for a few months before selling your home and paying off the full amount at once, especially if you used the HELOC for a home renovation project that improved your home value.

The benefits of home equity lines of credit are:

·        Easy approvals even with bruised credit

·        Lower interest rates than personal lines of credit

·        Can reborrow money as long as the line is open without additional credit checks or fees

The biggest advantage of home equity loans/lines of credit is also their biggest downside: it’s very easy to borrow a lot of money.

With a home equity loan, you can borrow up to 80% of your home’s value, which could be anywhere from $200,000 to almost $1 million. If you don’t first solve the problem that got you into debt in the first place, you may find yourself even worse off than before.

Before considering getting a home equity loan, be sure that you understand the consequences of improperly using your home equity. You might find that:

·        Cheap debt enables more spending

·        Using your home equity for debt prevents you from using it on home improvement or education

·        If you fail to make payments on your home equity product, the bank can force you to sell your home

 

2.     Personal Loan

Getting a personal loan is generally the most expensive option of getting out of credit card debt, but can be a good option for non-homeowners with poor credit.

Interest rates on personal loans usually range from 5% all the way up to 42%, however, so be sure to research loans before signing. You can compare personal loans here.

If the interest rate on your personal loan is greater than the interest rate on your credit cards, it’s a bad idea to take out a loan. You’ll end up paying more and your credit will be impacted.

When the interest rate on a personal loan is between 5% and 15%, it can be a great idea to get out of debt faster. If the interest rate is between 15% and 20%, it can still be a good idea, but you won’t save a lot of money – if any at all. If the interest rate is above 20%, you should consider not taking the loan, as you won’t save any money at all.

Benefits of personal loans:

·        Can be applied for even if you’re not a homeowner or have bad credit

·        Can consolidate multiple debts into one payment

·        Can get access to money in as little as 24 hours

Like with all these options, the danger of falling further into debt is there. You have to control your spending first before getting a loan, otherwise you can end up worse than before.

 

The Bottom Line

Paying off debts is always annoying. While getting a consolidation loan won’t immediately get you out of debt, it can really shorten the amount of time you have to pay it off, as well as save you a significant amount of money.

With credit card debt, it’s best to act quickly. The longer you wait to tackle your debt, the longer it has to build interest, and the more time you have to drop your credit score. Acting as soon as possible will preserve your credit score – and it’s cheaper!

 

 


Chris Chris 05/01/2019
Canadian personal finance buff and all-around writing enthusiast, Chris loves breaking down complicated money ideas to show that they're really not so complex. 
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