Worked Examples and Checklists
Debt consolidation loan in Canada: a worked example of when it saves money
An illustrative Canadian example of consolidating $20,000 of card and credit balances into one loan, showing the saving, the trap of a longer term and the alternatives.
A debt consolidation loan saves money when its rate is clearly lower than the average rate on the debts it replaces, and you repay it over a similar or shorter period, and you do not run the old balances back up. In the illustrative example below, moving $20,000 from cards averaging about 21% to an 11% loan over 4 years saves about $4,600 after fees. Stretch the same loan to 5 years to get a lower payment and much of that saving disappears; rebuild the card balances and you end up worse off than before.
Part of the personal loan cost worked examples. All figures illustrative.
The starting position
| Debt | Balance | Rate (illustrative) |
|---|---|---|
| Two bank credit cards | $12,000 | 19.99% |
| Store card | $5,000 | 29.99% |
| Unsecured line of credit | $3,000 | 12.99% |
| Total | $20,000 | weighted average about 21.4% |
The weighted average is (12,000 × 19.99 + 5,000 × 29.99 + 3,000 × 12.99) ÷ 20,000 ≈ 21.4%. For the comparison we round to 21%.
Step 1: what clearing the debt costs as it is
Card minimum payments are not designed to clear a balance on any schedule, so set a target instead: clear everything in 4 years. At 21%, that requires about $619.31 a month, with total interest of about $9,727.
Step 2: the consolidation loan
A lender offers $20,000 at 11% over 4 years with a $300 fee you pay at signing.
| Keep the debts (21%) | Consolidation loan (11%) | |
|---|---|---|
| Monthly payment over 4 years | about $619.31 | about $516.91 |
| Total interest | about $9,727 | about $4,812 |
| Fee | — | $300 |
| Total cost | about $9,727 | about $5,112 |
Monthly difference about $102.40; the $300 fee is recovered in about 3 months; total saving over 4 years about $4,615. You can rerun this with your own figures in the debt consolidation calculator.
Step 3: the longer-term trap
The lender also offers 5 years at the same 11%. Payment about $434.85, which feels like a big relief compared with $619. But total interest becomes about $6,091. You still save compared with 21%, but about $1,279 less than the 4-year option, and you are in debt a year longer.
Some consolidation offers go further: 7 years, a higher rate for weaker credit, or an insurance add-on. A consolidation at 18% over 7 years on $20,000 would cost far more in interest than clearing the original debt at 21% over 4 years. Always compare over the same period first.
Step 4: the behaviour trap
The most common way consolidation fails is that the cards are paid off, the limits stay open, and new balances build up. Within a couple of years the borrower has the consolidation loan and card debt. Protect yourself:
- Close the store card and any card you do not need, or ask for lower limits.
- Keep one card for emergencies, paid in full each month.
- Set the loan payment by pre-authorized debit right after payday, and prepay when you can: consumer loans can usually be prepaid without penalty (prepaying early).
- Build a small emergency fund so that the next surprise expense does not go back on a card.
Closing old accounts can affect your credit score in the short term by raising utilization and shortening your history; that is usually a smaller cost than new debt.
Alternatives to compare
| Option | How it works | Watch for |
|---|---|---|
| Unsecured consolidation loan | One fixed payment, set end date (compare with a line of credit) | Rate depends on credit; fees and add-ons |
| Balance transfer card | Promotional low rate on transferred balances for a period | Transfer fee; the rate after the promotion; new purchases |
| HELOC or mortgage refinance | Low rate secured on your home | Converts unsecured debt into debt on your home; long amortization; legal and discharge costs |
| Debt management program (non-profit credit counselling) | Counsellor negotiates reduced or waived interest; one monthly payment | Usually covers unsecured debts only; cards often closed |
| Consumer proposal (Licensed Insolvency Trustee) | Legal settlement under the Bankruptcy and Insolvency Act | Serious credit impact; for debts you cannot repay |
If you cannot qualify for a consolidation loan at a lower rate, or the payment is still unaffordable, talk to a non-profit credit counsellor before signing a high-cost loan; see unmanageable loan debt.
Questions for the lender
- Is the rate fixed? What is the APR including all fees?
- Will the lender pay the creditors directly, or will the money come to me?
- Can I prepay in full or in part without a charge?
- Is any insurance included, and can I remove it?
- Will the lender require me to close the paid-off accounts?
Frequently asked questions
Does consolidation hurt my credit score?
Applying adds a hard inquiry, and a new loan lowers the average age of your accounts. Over time, lower card utilization and on-time payments usually help. The net effect depends on what you do with the cleared cards.
Can I consolidate with a credit union if my bank says no?
Yes, credit unions set their own policies and may consider factors a bank does not. Compare APR and total cost the same way.
Is it worth consolidating a small amount?
If the saving is a few hundred dollars and there is a fee, maybe not. A focused payoff plan on the highest-rate card first can achieve much of the same result.
Should I consolidate student loans with other debt?
Government student loans have their own repayment assistance programs and rules. Moving them into a private loan can mean losing those features. Check the federal and provincial student loan sites first.
Sources
- Financial Consumer Agency of Canada — debt consolidation and managing debt
- Credit Counselling Canada — non-profit credit counselling and debt management programs
- Office of the Superintendent of Bankruptcy — consumer proposals and Licensed Insolvency Trustees
