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Debt Consolidation

Debt consolidation is the practice of combining your higher interest debts into one loan with a lower interest rate. This saves you money and simplifies your repayment structure and process. Debt consolidation can help you lower your monthly debt repayments, lower the interest rate on your debt amount, and as you pay down your debt total it can help improve your credit score.

There are various methods for debt consolidation but if you have a home there are some ways that can be worthwhile to explore. These include second mortgage options like a home equity loan or a home equity line of credit, and the option of a mortgage refinance. Because these are secured loans they will have a lower rate than your unsecured debts making them great options for debt consolidation.

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    If you are in a situation where you have various debts with high interest rates or a difficult payment schedule you should consider debt consolidation. Paying off multiple different debts at a time can be a burden on your finances and wellbeing. Credit cards and various other unsecured loans have high interest rates and it can be difficult to juggle repayments. By combining, or consolidating, your debts with a secured loan or financial tool you can simplify your payments and make your debt burden more manageable while having a much lower interest rate on the loan. There are many advantages to debt consolidation, including:
    • Lowering your monthly payments by placing them into a secured loan that allows a longer repayment structure.
    • Lowering your interest rate as secured loans are less risky than unsecured loans and have a lower rate.
    • Improving your credit score in the process by allowing you to continue making your payments with a more forgiving repayment plan.
    A debt consolidation plan that secures your new loan against your property will give you a lower rate, and allows you to use this new loan to pay off your various other debts.
    Debt consolidation can be a very beneficial process to help you out of your debt situation, however there are some risks one should be aware of. When applying for a loan you generally need a favourable credit score, generally in the mid-600s, to be eligible for a suitable loan that has a low interest rate and an amount suitable for debt consolidation. If the interest rate on your new loan is higher than your existing debt then it is not a suitable choice. Debt consolidation requires financial discipline. If you improperly use your new loan or continue to accrue high interest debts on your credit cards you run the risk of increasing your debt. Similarly, the process of paying down your debts can take many years depending on your total amounts and requires long-term discipline. If you choose to go with a second mortgage or mortgage refinance for your debt consolidation you need to be aware of the associated costs and fees. Your lender or broker may charge you fees for processing new loans or for changing your existing agreements. If the fees and costs exceed the savings you would make then it is not suitable to proceed.
    A home equity line of credit, or HELOC, is an excellent tool for debt consolidation. It is a second mortgage that provides a line of credit, allowing you to access the built up equity you have in your home. You can use or borrow from the HELOC on demand and then pay it back over time, similar to how a credit card works. Because a home equity line of credit is secured against your property it has a lower rate than unsecured loans and debts. Debt consolidation requires the combining of your debts into one package, so you can pay off your existing debts using your home equity line of credit which combines the amount into one place. You then take advantage of the lower interest rate and the simplified payment structure to pay off your debt.

    Tips for Getting a Debt Consolidation

    Because the burden to prove eligibility is greater on self-employed individuals, it pays to be well prepared before applying for a loan. The following should be considered before going into apply for a Self-Employed Mortgage:

    Using a Home Equity Loan for Debt Consolidation

    A home equity loan is another type of second mortgage that can be used for debt consolidation. It provides you with a lump sum of money that can be used and is paid back in installments with interest. It is similar to a HELOC but different in that you get the whole sum as a loan instead of as a line of credit.

    For debt consolidation purposes a home equity loan can be good as you can borrow the exact amount needed to simplify your debt situation. Since it is a secured loan the interest rates will be lower than your unsecured loans. This lets you have a lower rate for your debt, an easier time paying it back, and over time it can help you improve your credit score.

    Using a Mortgage Refinance for Debt Consolidation

    A mortgage refinance is when you have an existing mortgage agreement that you break to start a new mortgage agreement. For the purposes of debt consolidation you would combine your remaining mortgage and your debts into a new amount for your new mortgage term. There may be fees and penalties associated with a refinance that can exceed the possible savings so it is important to assess all the factors before you make your decision.

    Since a mortgage refinance is a secured loan it will have a lower rate than unsecured debts like credit cards. Depending on the penalties and fees, it can be a useful tool for debt consolidation. By combining your debts into a secured loan like a mortgage you can reduce the interest paid and have a simpler repayment plan.

    Other Methods for Debt Consolidation

    There are other methods and tools that you can use for debt consolidation but they may not be as advantageous. They can include:

    • Personal Line of Credit or Debt Consolidation Loan: These are unsecured loans so while they may have lower interest rates than credit cards they will have higher rates than secured loans like second mortgages. They may be better used for debt consolidation of smaller amounts.
    • Debt Management Plans: Debt management plans are provided by credit counseling organizations that help you with debt consolidation. They send a proposal to your creditors to group all your credit card payments into one monthly payment. Your creditors have to agree with the proposal but they can be a useful tool to explore.
    • Credit Card Balance Transfers: Some new credit cards allow a period of low or no interest when they’re newly opened as a promotional rate. This is a riskier strategy for debt consolidation and should only be used if the amount is relatively small and manageable to pay off during the promotion.

    Is it harder to get a mortgage if I am self employed?

    Obtaining a Self-Employed Mortgage can be more difficult than a traditional mortgage as the borrower has to take extra steps to prove to the lender that they are capable of maintaining regular payments on their mortgage. It is possible that depending on the financial institution, that Self-Employed Mortgages are not offered at all. Where they are offered, there is also the chance that banks will significantly increase the interest rates for these loans, making them a more difficult consideration for borrowers. To give a better chance at being approved, lenders are expected to offer a large down payment, up to 20% or higher, as well.

    Another difficulty associated with Self-Employed Mortgages is the lack of a T4. A full time Employee can provide proof of income through a simple T4, however a self-employed individual must provide a stated income form, which shows the amount the potential borrower claimed to have earned, and then must provide documentation which can prove the stated amount is accurate.

    Lenders will also apply the Debt Service Ratio when considering your eligibility for a loan. This is a measurement which determines your ability to maintain regular payments on a loan after all your financial responsibilities have been considered. These include monthly bills, car loans, lines of credit, student debt and any other loans.

    If after considering these other factors the bank is confident that you are able to meet their requirements for regular payments, you will be eligible for a loan.

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    Commonly Asked Questions

    Debt consolidation is a good idea if you have a variety of high interest debts or loans. By combining your higher interest debts into one loan with a lower interest rate, you save money and simplify your repayment. Debt consolidation is a good way to improve your credit score over time.
    There are various strategies for debt consolidation and many include taking out a secured loan for the purposes of combining your other debts together. Over the short term this can make your credit score slightly worse but as you pay off the secured loan your credit score will continue to improve.
    A debt consolidation plan that secures a loan against your property will give you a lower rate than your unsecured loans, allowing you to use this new loan to pay off your other debts. This strategy allows you to reduce your monthly loan repayments, pay a lower interest rate, and improve your credit score over time.

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