When you carry a lot of credit card debt, typically on more than one credit card, a common debt management solution is to get a debt consolidation loan. But, if you’ve fallen behind on your monthly bills or have too much debt, your poor or bad credit history will affect your ability to consolidate your debt at a reasonable interest rate. This may make you consider a bad credit debt consolidation loan.
If you have a low credit score, it is important to think through all your bad credit consolidation options before proceeding with any solution. You owe it to yourself to compare the costs of a debt consolidation loan with other debt relief options like a debt management plan or consumer proposal.
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Should you even get a bad credit debt consolidation loan?
A debt consolidation loan sounds like a simple way to manage debt payments, save on interest, and pay down debt faster.
If the interest rate on your debt consolidation loan is lower than what you are paying on your credit card now, you can pay down your debt sooner because more of your monthly payment will go towards the principal than interest.
However, you need to have a good credit score or have assets you can offer as collateral to qualify for a low-interest rate loan.
The problem is, many people who find themselves struggling with monthly bill payments have a poor credit score – either because they have too much debt or because they have already defaulted on a monthly payment.
Having a bad credit score means most low-interest personal loan providers – from a bank or credit union, for example – are off the table. If your credit score is below 600, you will likely be looking at a very high-cost loan.
While there are lenders who specialize in offering unsecured debt consolidation loans to borrowers with low or very bad credit, a high-interest financing loan to consolidate bills may not be the best answer either. Bad credit personal loans appear attractive due to their repayment terms and low monthly payment, but the interest rates are often as high as 45.99%. So, while not as bad as a payday loan, they are still not a good way to deal with problem debt. A personal loan like this can also carry origination fees or insurance requirements, which can double the cost. Always read the terms of the agreement carefully and understand your rights and responsibilities under the loan.
Traditionally a secured consolidation loan like a home equity line of credit or car loan offers a lower interest rate. However, if you have bad credit, even a secured consolidation loan can be costly. Car title loans, for example, can carry an interest rate of 35% or more.
Typical Loan Consolidation Example
You owe $15,000 on multiple credit cards and several outstanding bills that you want to consolidate. You find a loan provider willing to loan you $15,000 at 35.99% interest.
Biweekly payments $314.54
Number of payments 78
Total repaid over life of the loan $24,534.29
Total interest $9,534.29
Here are 5 questions you should ask yourself before consolidating your debt when you have a low credit score:
- What is the interest rate?
- What additional fees will I be charged?
- How much will I pay over the life of the loan?
- Can I afford the monthly payments?
- What are the penalties or fees for late payments?
Answering these questions honestly will help you determine whether bad credit consolidation loans are worth it.
If you can’t afford the monthly payment, then it’s time to consider a less expensive alternative if you are looking for debt help.
When to avoid bad credit consolidation loans
The larger your debt consolidation loan, the more challenging it will be for you to repay the loan. Bad credit consolidation loans above $10,000 are risky.
If the rate on your debt consolidation loan is higher than what you are paying today, it may not help you get out of debt. Smaller weekly or biweekly payments may look attractive, but most of those payments go towards interest.
A bad credit consolidation loan may not be your best option if:
- You are currently only making the minimum monthly payment on your debts
- Your debt-to-income ratio is above 40%
- The interest rate is higher than your current debt
- You can’t get enough to consolidate all your problem debt
- You have to commit to a lot of extra fees like loan insurance
- Your current outstanding balance is more than you can afford to repay
- You are at risk of a job loss or other income reduction that could lead to default
A debt consolidation loan may seem like the best fix, but it may not be. It’s important to remember that a bad credit debt consolidation loan is still a loan, and lenders seek to profit from this product. Most of your monthly payments will still be going towards the high interest on your loan. Extending your repayment period for many years will lower your monthly payment but can also delay your financial recovery.
What you need to do before applying
Before you complete any loan application, either in person or online, you should:
Check your credit report. Get a free copy of your credit report from either Equifax or TransUnion. Fix as many errors and negative information regarding your credit accounts as you can. You will have to pay if you want to know your credit score. Improving your credit score, even a small amount, can increase your chances of qualifying for a lower interest rate.
Avoid multiple applications. Every time you apply for a loan, it is known as a hard hit on your credit report, which will be reported to the credit bureaus. Multiple applications will lower your credit score even further.
Prepare a budget. Use an online loan calculator to determine the maximum amount of monthly payment you can afford without continuing to go into debt. If you cannot find a loan that fits your budget, consider alternatives such as a debt management plan or a debt proposal to your creditors.
Consider options that lead to debt relief
Credit card debt, utility bills, cell phone bills, overdrafts are debts with one thing in common – these are unsecured debts that typically build up over time or that continuously recur because you have been using credit to pay for living expenses. Adding more bad debt, especially a high interest personal loan, won’t help you get out of debt.
If you have too much debt to be fixed through a consolidation loan, there are better options.
Debt Management Plan
If you are not eligible for a low interest consolidation loan, you may want to consider a debt management plan. A non-profit credit counsellor can work with you and your creditors to arrange a repayment plan.
You will be required to pay back 100% of what you owe; however, you will have up to five years to do so. Spreading out the payment of your current balance over five years can certainly lower your monthly payment. Since many creditors are willing to freeze interest, a debt management plan can be a better alternative than a high-interest consolidation loan.
A fee of 10% of the debts included in your debt management program will be added to your monthly payments.
There are disadvantages to a debt management plan. Participation by your creditors is voluntary, and student loans, payday loan debt, and income tax debt are generally not eligible through a credit counselling option.
Debt Settlement or Consumer Proposal
What do you do if you can’t afford to pay your bills? A better alternative may be to offer a debt settlement or consumer proposal to your creditors.
Typical Consumer Proposal Example
You make a deal to settle $15,000 in credit card and other debts for $6,000 paid bi-weekly over 3 years. Based on your income and assets, your creditors agree to those terms.
Biweekly payments $76.92
Number of payments 78
Total repaid $6,000
A consumer proposal allows you to consolidate many forms of unsecured debt, interest free, and you repay only a portion of the debt you owe. It is filed with a Licensed Insolvency Trustee, but you are not filing bankruptcy.
As a legal debt settlement program, a consumer proposal is binding on all creditors. It puts an end to harassing calls from creditors and any legal action taken against you like a wage garnishment.
But what about improving my credit score?
How does a bad credit consolidation loan affect your credit? While a personal loan through a financing company will look better on your credit history than missed payments, you will still carry a lot of debt. High debt balances affect your credit score negatively. Lenders also look at factors beyond the credit score they see. Subprime loans could still be viewed poorly if you try to apply for a future loan.
One of the most common reasons people with poor credit insist on searching endlessly for a low rate consolidation loan for bad credit is because they do not want to hurt their credit any further. Many people are enticed by lending companies that offer to ‘level up’ your loan as a way to improve poor credit. Loan companies use a lot of terms: level up, lend up, ladder up. They all mean the same thing.
How do you level up a loan?
Make your payments for a specified period, usually, at least 12 months, and the lender will either increase your credit limit or offer you a lower rate loan.
The thing is, to qualify for an interest rate improvement, you must have a stable credit profile. That means no other hits to your credit report. No new loans, no re-drawing on your credit cards if this keeps your debt load high. And offering to increase your credit limit, when you are already struggling to repay your debt, is not a good deal for you.
The truth is that your credit score can improve quicker with a consumer proposal.
Why? Because no more debt is the fastest way to boost your credit.
Both a debt management plan from a non-profit credit counselling agency and a consumer proposal have the same effect on your credit report. Both will be viewed as a repayment program and will remain for a maximum of six years.
With a proposal, your monthly payments are much lower, which improves your overall cash flow. Since you now have a balanced budget, you can begin to set aside some savings. At the end of the proposal, all your debts are eliminated. You start from zero, a clean slate.
A consumer proposal can help you rebuild your credit by removing old debt. In effect, you are resetting the clock. Old debt is gone, lowering your utilization rate. Over the next couple of years, you can begin to build a new and better credit history.
Improving your credit score involves a few steps.
- Eliminate high interest debt.
- Save an emergency fund or down payment, so you don’t have to rely on so much credit.
- Apply for a secured credit card to re-establish a positive credit history.
- Keep all your bill payments current and pay any balances in full each month.
- Limit your credit consumption going forward.
What to do when you need debt help with bad credit
If you’re having trouble staying on top of bills or credit card debt payments and your credit score is limiting your ability to get an affordable loan, talk with a Licensed Insolvency Trustee about your options.
Debt problems are not solved by taking on more debt. You need to look beyond a high cost bad credit debt consolidation loan.
A trustee will run the numbers, based on your personal financial situation, and help you compare a consumer proposal with a debt consolidation loan to see which program can achieve your debt consolidation goals and get you started on repairing your bad credit, all while eliminating your debt.