What is Debt Consolidation?

On average, Canadians had $21,348 in consumer debt in 2016, a number that has grown 2.7 per cent in the past year. Managing debt is a struggle that many Canadians are all too familiar with. Understanding how debt consolidation works is the first step towards rebuilding your finances and managing debt more effectively.

If you are exploring debt consolidation as an option for managing debt, we’ve outlined some key points you should know about what debt consolidation is and how it works.


Debt consolidation happens when a borrower takes out a new loan to pay off a number of small loans or debts they currently making regular payments on. This process involves bringing together multiple debts from different sources into one loan, which is referred to as ‘consolidation.’

How does debt consolidation work?

Since each loan has its own interest and payment terms, each one is an individual contract.  With each contract, the borrower agrees to pay a loan back over a period of time.

In order to consolidate debt, a new larger loan is used to pay off smaller debts.  Once debts have been consolidated, you will have one payment to make each month instead of several payments to multiple lenders.

Debt consolidation is also used to lower interest rates. Small loans usually have higher interest rates, but with larger loans you can get a better interest rate. By lowering interest rates, a larger percentage of monthly payments goes towards the principle, which helps to reduce debt faster.

Principle refers to the amount still owed on a loan that is separate from interest. If you take out a $60,000 loan, the principle is $60,000. If you pay off $35,000 on this loan, the remaining $25,000 refers to the principle.

When to use debt consolidation

Debt consolidation could be used for a variety of situations including:

  • Credit card debt
  • Reduce consumer debt (collection of debts from retail stores, interest car loans, and other high interest loans)
  • Reduce principle for loans to avoid paying high interest

Borrowers decide to use debt consolidation as a tool to manage their finances for a number of reasons:

  • Simplifies finances: Borrowers only have one debt payment every month instead of having many payments to keep track of and pay on time
  • Reduces interest rate: It reduces interest rates by paying off high interest debt with lower interest rate loans
  • Smaller monthly payments: With debt consolidation, borrowers can make a smaller monthly payment by consolidating at a lower interest rate or have a longer period of time to pay back the loan

How to get a debt consolidation loan

To be eligible for a debt consolidation loan, creditors are looking for the following criteria:

  • Acceptable credit rating (lending institutions will use your credit score and payment history to establish risk)
  • Regular income, which shows the lender that a borrower will be able to manage monthly payments

Creditors want borrowers to prove they can make monthly payment on a consolidated loan while paying regular monthly expenses.

If you have a lower credit score, there are other options for consolidating debt. You can request all debts be consolidated on a low interest credit card through a credit card balance transfer. Having all debts on a low interest credit card will help to pay down the principle faster by having a lower interest on your loan.

Another option is to have a family member or friend co-sign a loan. If your co-signer has a strong credit history, the lender is more likely to sign off on the loan. It is essential the co-signer be knowledgeable of their responsibilities.  If the borrower is unable to make payments on a loan, the co-signer will be burdened with the responsibility of making the payments.

Debt consolidation can be a step towards rebuilding your credit, but it is not a blanket solution for all financial challenges.  Whether or not it is right for you depends on a number of factors including financial goals, credit score and your own personal financial habits. Consolidation can provide a simplified plan for how to reduce your debt and save for what matters most.

To learn more about best debt consolidation options or create a plan, contact North Creek Financial today! We are committed to providing simplified financial solutions customized to your needs.