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

Usually, there are three big reasons to do it. First, focusing on a single monthly debt payment is much easier than chasing due dates for a multitude of creditors. Second, you might be able to get a lower interest rate on your debt consolidation loan than you were paying on several of your smaller loans. Third, especially if you were able to get a lower rate, the monthly debt payment on your consolidated loan may be smaller than the sum of what you were paying before to your many creditors.

How to consolidate debt, though, is anything but straightforward. Some options involve low-interest rates but the repayment period is so long that you may end up paying more interest on your debt overall. But math isn’t the only consideration. Psychology matters, too. Sometimes, a smaller payment and a flexible repayment schedule just enable borrowers to run up their credit cards all over again.

So what’s the best way to untangle your debts? Global News asked Scott Hannah, head of the B.C.-based Credit Counselling Society and Sheila Walkington, co-founder and CFO of Money Coaches Canada, to order 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 that isn’t too far off and, if you chose a fixed interest rate, predictable and generally mandatory monthly payments.

“That is why we recommend them,” Hannah said.

Term loans may come with interest rates slightly higher than those available through a line of credit or a mortgage. And because you have to extinguish the loan within a set amount of time, your debt repayments are also quite a bit higher than what you’d usually get away with using a line of credit.

But the more structured nature of term loans generally helps people stay on track, Hannah said. And a term loan from a bank or other mainstream lender still comes with lower interest rates than the 20% charge you’d typically get on a credit card.

Another advantage of term loans is that there are usually no prepayment penalties, Walkington noted.

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

2. Unsecured lines of credit

These days, unsecured lines of credit come with relatively low-interest rates of 5-8%.

They are “a good way to consolidate debt without locking yourself into a high monthly payment,” Walkington said via email. At the same time, “the flexibility to pay more than the minimum makes it easy to adjust your payments to your cash flow.’

But those traits 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, a line of credit may be difficult to pay down and easy to run up again,” Walkington said.

Also, the interest rate on a line of credit is variable. This means that both your minimum payment amounts and overall interest costs may rise if interest rates increase, as they have since July 2017.

3. Secured lines of credit (HELOCs)

Home Equity Lines of Credit, or HELOCs, are secured by your house and come with even lower rates (think 4.5 percent). Another perk is that your ability to borrow is linked to your home equity, so that your credit limit goes up as you pay down the mortgage, potentially freeing up room to consolidate higher-rate debt.

Other than that, HELOCs have all the pros and cons of their unsecured cousins, including variable interest rates.

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

That’s because making only minimum payments on your HELOC comes with “the double whammy of not only not paying off the line of credit, but negating any progress on paying down your mortgage if one keeps running up the HELOC,” Walkington said.

4. Mortgage refinancing

By folding your high-interest debt into a mortgage you may be able to lock in an interest rate as low as 3.39 percent, according to a financial product comparison site.

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

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

If you have, say, $80,000 in credit card debt and are spreading it out over 20 or 25 years, Hannah said, you have to ask yourself, “how much interest am I going to have to pay on that debt over that amount of time?”

The answer may be: More than if you had not consolidated your liabilities.

Mortgage refinancing also comes with fees and potential penalties for pre-paying the debt before the end of the term.

5. Second mortgage

A second mortgage is a loan backed by a home that is already mortgaged. You’ll be paying a higher interest rate on a second mortgage because your lender is second in line on your property’s title. If you default, it’s the lender on your first mortgage that will get first dibs on your property.

Second mortgages, though, can still be a way to turn multiple debt charges into a single, lower payment. They are “a last resort,” Walkington said.

But taking out a second mortgage means committing to additional fixed costs for the long term, Hannah said. And even if you choose a fixed interest rate, those costs are likely to rise at renewal if interest rates keep going up.

And if you run into a snag, a second mortgage may be difficult to refinance, Walkington said.

6. Getting a co-signer on 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 if you have a bruised credit record or little credit history. This, though, puts your family and friends at risk if you default on your payment, which can put a significant strain on relationships, both Hannah and Walkington noted.

And co-signers often don’t realize that adding themselves to your loan will limit their own ability to borrow, Hannah said. Lenders will count your debt as their debt when they apply for credit.

In most cases, Hannah said, “it’s best to keep friends and family out of it.”

If you want to discuss home equity loan options to consolidate your debts, reach out to Private Mortgage Source now at 647-479-9849.

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Tracy, a 61-year-old pensioner, recently sold her townhouse to help fund her retirement. Knowing that she needed an investment that produced a stable and predictable income source, a friend of hers suggested she try private lending.

This friend knows a homeowner whose home is worth $3.2-million with a $1-million mortgage and who is looking to borrow $200,000. This homeowner is willing to pay 7% per year for a term of three years.

Tracy is considering the deal because 7% interest is four times what her bank is offering on their term deposits. She feels there would be some protection because a lien would be registered against the borrower’s home, thus eliminating the risk of the property being sold or re-financed.

Before agreeing to these terms, Tracy wrote to me for my opinion.

Cash flow and rates

To make this decision, Tracy requires a lot more information. She should take the same precautions that a bank would and collect personal and financial information on the borrowers.

My main concern would be their cash flow as they have an existing $1-million mortgage. I would want to verify their employment, salaries, credit scores and their plan with respect to paying back the loan.

I also need to know how the funds are going to be used. If the money is being borrowed to service existing debt, that’s a concern as it likely means there is a cash-flow issue.

Another concern is that the 7 per-cent interest rate seems low. Rates charged are risk-based, and private loans are often risky. Any borrower dealing with a private lender is usually doing so because they have exhausted all other options.

Their parents, banks, credit unions, and secondary or alternative lenders have likely turned them down or were willing to lend money, but at a much higher rate than 7%.

Often, borrowers are turned down for good reason, likely because they can’t afford or shouldn’t be borrowing more money. Due to the increased risk, most private-lending deals pay 10-20 per-cent interest.

I also think the term is too long. I wouldn’t be comfortable with a three-year deal.

I would only consider a one-year deal, which could be renewed but at the discretion of the lender.

Know the reasons

For me to consider lending, I would need to know the reason their bank turned them down. Maybe it was simply due to a small technicality, which had nothing to do with their creditworthiness or ability to service or pay back the loan.

I may consider lending the funds in this case, or if, for example, they are borrowing the funds to simply fix up their home before selling it. Or maybe they just need a year to sort out their financial affairs before being able to qualify for a loan with a traditional lender.

What a private lender wants to avoid is a situation where the borrower can no longer make payments or pay out the loan by the end of the term. If that were to happen, then the lender would have to force the sale of the property, which is expensive and time-consuming.

In the end, Tracy decided against private lending. She wasn’t comfortable lending $200,000 as it made up 40% of the proceeds of the sale of her townhouse. She didn’t want to risk having that much of her retirement tied up in one investment.

My recommendation was that she lend no more than 10% of the sale proceeds.

Tracy instead decided to invest in a mortgage fund where professional underwriters complete the due diligence on the borrowers, something Tracy wasn’t willing or able to do herself.

The rate of return is approximately the same and the fund doesn’t tie up her money for three years.

Want to become a private lender? Contact Private Mortgage Source and let’s discuss private lending options that minimize your risk will giving maximum month over month returns – contact info@privatemortgagesource.com.

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The self-employed are among the growing number of Canadians turning to private lenders in order to obtain a mortgage.

While many prospective homeowners are driven to alternate lenders because of government-mandated stress tests and poor credit scores, the self-employed often have additional burdens to overcome in proving their income.

“There’s more and more people seeking private loans than ever before and that’s a direct result of government making it more and more difficult to qualify,” says Dan Caird, a mortgage agent with Dominion Lending Centres.

According to the Bank of Canada, private lenders have doubled their share of the mortgage market in Greater Toronto since 2015, accounting for eight per cent of mortgages in 2018.

These lenders are less concerned about income and more focused on the property’s value in case they have to foreclose. The tradeoff is higher interest rates and fees.

Still, the option can be helpful for the self-employed who expense as much as they can in order to reduce their taxable income and who have a strategy to beef up their credit score with a goal of returning to a traditional lender.

Caird said it’s usually more financially advantageous to “expense the heck out your business” and show less income.

“Sure you’re going to pay a half a per cent, a per cent, sometimes two to three per cent 1/8more 3/8 on your mortgage but …they usually end up coming out ahead by claiming less income and just paying a bit more on the mortgage,” he said in an interview.

However, the writeoffs make it harder for lenders to obtain the 35 to 44 per cent debt-to-income ratio sought by traditional lenders.

Proving a sufficient track record of income to qualify for a mortgage can be the biggest challenge for people who work for themselves.

“Assuming a self-employed borrower had great credit and ample equity, we used to be able to simply state their income to the bank and show a notice of assessment to prove no taxes owing,” said Robert McLister, found of mortgage news website RateSpy.com

“Those days are long gone.”

The government now wants verifiable proof of true earnings while the stress test makes the hurdle even higher by requiring almost 20 per cent more provable income to qualify for the same mortgage available in 2017, he said.

That has pushed more people to alternate lenders.

“Self-employed mortgages without traditional proof of income are a different animal from your cookie cutter AAA bank mortgage,” McLister added.

The Canada Mortgage and Housing Corp. is trying to ease the paperwork required to obtain mortgage loan insurance, said Carla Staresina, vice-president risk management, strategy and products.

It introduced changes last October that suggest additional factors lenders could consider if the borrower has been operating their business for less than two years, including having sufficient cash reserves, predictable earnings, acquisition of an established business and previous training and education. It is also encouraging acceptance of a broader ranger of documents.

“Our aspiration really is to make sure everyone in Canada has a home they can afford and that meets their needs,” Staresina said from Ottawa.

“We know self-employed Canadians make up about 15 per cent of Canada’s labour force and so we want to make sure that any difficulty that they have in qualifying for a mortgage is mitigated and that we’ve got some options for them.”

McLister said the program will help “at the margins,” particularly those who recently started a business or bought an established operation.

Caird said there’s been some other steps in the right direction. He pointed to a new product from the Bank of Nova Scotia that allows incorporated companies to use retained earnings in the business to help applicants qualify.

Genworth Canada and Canada Guaranty also have programs to help self-employed borrowers, but require the business be open for at least two years.

The mortgage broker’s task is to convince lenders that the borrower is a good credit risk by adding back specific deducted expenses to net income to improve the debt-to-income calculation, said Caird.

While having a sound credit history is very helpful, mortgages can still be obtained for those with less-than-stellar records, for a cost.

Three essentials for borrowers are to have up-to-date taxes, be organized and consult a mortgage broker long before the mortgage is required.

“If your taxes aren’t up to date it’s going to be next to impossible to get a lender to give you a mortgage at any sort of reasonable rate or term.”

Let Private Mortgage Source be your first choice when seeking a mortgage as a self-employed person. Contact us for more details.

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