Debt Consolidation Loan vs Line of Credit

Written by Amanda B. – a Budgeting Client of 4 Pillars (edited by Benjy Houser)

Should I take a Debt Consolidation Loan or a Line of Credit to fix my Debt Problems/pay off my debt?

This is a question that many people ponder, so we thought we would let a client share their own take on the problem – here are Amanda’s thoughts:

Like majority of newlyweds, my new husband and I had racked up our Visa bill to a point where we are only paying for the interest rate each month and not putting our hard earned money towards the principal. We just had to do something about this so we looked into doing a Debt Consolidation Loan or a Line of Credit with our current bank. As we sat down with the financial advisor at the Bank to discuss our situation, he has given us a couple options and we considered the advantages/disadvantages of each.

Option 1: A CONSOLIDATION LOAN – would be one new loan that would pay off our Debts for us and give us one single payment. This loan would force us to make a steady monthly payments that automatically paid both Principal (the actual debt owing) & Interest (the cost to carry the debt) at fix 4-5 year term (loan time line). The benefit is it FORCES us to get out of debt; the downside is that the monthly payment on the loan was a bit more money monthly than our current debt payments. The reason it cost more per month is that it is a combo of principal and interest, whereas regular credit card payments are simply interest alone with almost no money going to pay down the debts principal balance. Also, to help reduce the chance of us getting back into credit card debt again, it was recommended that we cut up our extra credit cards and only keep one and reduce the limit to a very low limit.

 Option 2: LINE OF CREDIT The second option would be to get a Line of Credit to pay off all of the debt. It would be at a lower interest rate than the consolidation loan, but with no fixed term, and interest only payment. The Benefit with this is that The PAYMENT is much LOWER than the consolidation loan. This is because a line of credit makes you pay only interest and no principal. But the downside of that is that we could be stuck in debt forever unless we really force ourselves to pay off some principal each month. And with a line of credit as you do pay it down, the same amount you pay down become available to spend if you want. So to make this plan work we would have to aggressively avoid spending any of the money that is available and really show a lot of self-control.

 

After our research, we decided to go with the Debt Consolidation Loan. The Line of Credit option seemed attractive since it was just a nice big loan, and we could do whatever we want with it, with no automatic payments and just “pay as you go” and not have a deadline to when you have to pay it off by. Plus, it was a bonus to have the lower interest rate than the consolidation loan. But, we know ourselves and our spending habits, and having available line of credit money to spend is just TOO easy and too risky for us. So to us the consolidation loan seems to be the most favorable since it’s guaranteed we would have our debts all paid off in 4 years and be financially free! So the Consolidation Loan was a safer bet as it forced us to get out of debt and there was no way to spend more money from the loan.

Our Comments – the bank generally only offer these 2 options for clients that have good credit. So a Consolidation Loan or Line of Credit can be great if a client has great credit, but what about everyone else? Many Canadians find it impossible to qualify for these bank debt solutions, especially those who have spotty credit or missed payments or very high debt loads. If you want a consolidation loan but cannot qualify for it, please reach out to our office to look at our Debt Consolidation / Debt Restructuring program. Our program does not have strict requirements like Bank loans and almost anyone can qualify. Reach out to us for a free consultation to see if our program is a good fit to help you achieve your own debt freedom.