Credit line? Refinance Mortgage? Experts Evaluate The Best And Worst Options For Debt Consolidation – National

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The idea behind debt consolidation is simple: you take out a single large loan to pay off all or most of your other, smaller, liabilities.

There are usually three main reasons for this. First, it’s much easier to focus on a single monthly debt payment than it is to keep track of due dates for a multitude of creditors. Second, you may be able to get a lower interest rate on your debt consolidation loan than you paid on several of your smaller loans. Third, especially if you were able to get a lower interest rate, the monthly debt payments on your consolidated loan may be less than the amount you previously paid to your many creditors.

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However, debt consolidation is far from easy. Some options include low interest rates, but the repayment period is so long that you may have to pay more interest on your debt overall. But math isn’t the only consideration. Psychology also plays a role. Sometimes a smaller payment and a flexible repayment schedule just allow borrowers to recharge their credit cards.

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So what’s the best way to unravel your debt? Global News asked Scott Hannah, director of the British Columbia-based Credit Counseling Society, and Sheila Walkington, co-founder and CFO of Money Coaches Canada, to rank the debt consolidation options from best to worst. Their ranking was identical:

1. Term Loans

The nice thing about term or personal loans is that they have an end date not too far away and, if you have opted for a fixed interest rate, predictable and usually mandatory monthly payments.

“That’s why we recommend them,” says Hannah.

Term loans can come with slightly higher interest rates than those available through a line of credit or a mortgage. And because you have to pay off the loan within a certain period of time, your debt payments are also a lot higher than you would normally get away with a line of credit.

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But the more structured nature of term loans generally helps people stay on track, Hannah said. And a fixed-term loan from a bank or other mainstream lender still has interest rates lower than the 20 percent fee you typically charge on a credit card.

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Another advantage of fixed-term loans is that there are usually no early repayment penalties, according to Walkington.

If you qualify for a loan with one payment that you can manage and have a fairly stable financial situation, this is the way to go, Hannah said.

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2. Unsecured lines of credit

Unsecured credit lines are now associated with relatively low interest rates of 5-8 percent.

They are “a great way to consolidate debt without being tied to a high monthly payment,” Walkington said via email. At the same time, “the flexibility to pay more than the minimum makes it easier to adapt your payments to your cash flow”.

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But these features also make lines of credit a potential slippery slope that leads many borrowers into deeper debt, both Hannah and Walkington told Global News.

“Without discipline, it can be difficult to repay and easily renew a line of credit,” said Walkington.

The interest rate for a credit line is also variable. This means that both your minimum payment amounts and the total interest cost can increase if interest rates increase, as has been the case since July 2017.

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3. Secured credit lines (HELOCs)

Home Equity Lines of Credit, or HELOCs, are backed by your home and available at even lower rates (think 4.5 percent). Another benefit is that your borrowing is tied to your home equity, so as you pay off the mortgage your credit limit goes up, potentially creating room for higher-interest debt to consolidate.

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That being said, HELOCs have all of the pros and cons of their unsecured cousins, including floating rates.

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However, when it comes to psychological debt traps, HELOCs can be even more insidious, according to Walkington and Hannah.

That’s because making minimal payments to your HELOC comes with “double the hassle of not only not paying off the line of credit, but negating any progress in repaying your mortgage if one continues to power up the HELOC,” said Walkington.

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4. Mortgage refinancing

When you convert your high-yield debt into a mortgage, you might be able to set an interest rate of just 3.39 percent, according to the financial product comparison site RateHub.ca.

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With a fixed rate and low monthly payment, this can be a “free out of jail” opportunity to consolidate debt, “Walkington said.

But the math may not be cheap, as the low interest rate suggests, both Walkington and Hannah noted.

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For example, if you have $ 80,000 in credit card debt and it’s spread over 20 or 25 years, Hannah says, you need to ask yourself, “How much interest do I have to pay on that debt over that time? ? “

The answer can be: more than if you hadn’t consolidated your debt.

Mortgage refinancing also comes with fees and potential penalties for repaying the debt before the term expires.

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5. Second mortgage

A second mortgage is a loan that is secured by an already mortgaged home. You pay a higher interest rate on a second mortgage because your lender ranks second in terms of the title of your property. If you default, it is the first mortgage lender who receives the first dibs on your property.

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However, second mortgages can still be a way to convert multiple debts into a single, lower payment. They are “a last resort,” said Walkington.

But taking out a second mortgage means committing to additional fixed costs over the long term, Hannah said. And even if you do opt for a fixed rate, if you renew, those costs will likely increase if rates keep rising.

And if you run into a catch, refinancing a second mortgage can be tough, Walkington said.

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6. Get a co-signer for a debt loan or line of credit

Adding a friend or relative to your debt consolidation loan can help you access credit or a lower interest rate when you have a damaged credit record or low credit history. However, doing so puts your family and friends at risk if you fail to make your payment, which can put a significant strain on relationships, both Hannah and Walkington noted.

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And co-signers often don’t realize that adding it to your loan will hurt their own creditworthiness, Hannah said. Lenders count your debts as their debts when they apply for a loan.

For the most part, Hannah said, “It’s best to keep friends and family away from it.”

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