Debt Consolidation: Get Back On Track

The world is being hit by a debt tsunami. Canada has seen the most notable rise in debt to GDP ratio, according to a July report by the Institute of International Finance. An increasing number of Canadians will need to think about debt consolidation. The debt to GDP ratio is a simple way of comparing a government’s debt to the gross domestic product (GDP), which is the value of all the goods and services produced in a specific time period. GDP is an important indicator of economic performance. This ratio demonstrates how much a country makes and compares it to how much the country owes.

There has been a significant rise in debt to GDP ratio in Canada

Source: The Institute of International Finance, 2020

The Bank of Canada is taking measures to support the recovery of Canadian economy. However, businesses can’t wait and need to take measures to protect themselves. What this means, if you are a business owner, is that you will need to take control of your liabilities and take a hard look at how these liabilities are affecting you.

Chances are you have some debt, whether it is from your credit cards, mortgage, taxes or loans. You are not alone. According to Equifax Canada, the average debt of Canadians has increased to $74,897, up 3.3% compared to the third quarter of 2019. Small businesses on average have taken on more than $150,000 in debt, according to a survey conducted by the Canadian Federation of Independent Businesses in June.

Cashflow is the life blood of any business. If your debt is affecting your business’s cash flow, there is something you can do about it: to keep the cash running and to restructure your debts, you need to consolidate your debts.

A debt consolidation loan would cover all your current debts and you would have to make just one payment per month instead of multiple payments.

Why should you consolidate your debts?

There are several reasons you should consider debt consolidation:

1. Simplification: Your debt payments become easier. Instead of paying off several loans, all with different terms and interest rates, you would have just one lender and one payment a month.
2. Better terms: When you consolidate your debts, you shift them to a new lender and can get a new loan with better terms.
3. Lower interest rate: Along with better terms, you’re likely to get a lower interest rate. This would be a particularly good time to consider debt consolidation as interest rates are at an historic low and credit cards charge anywhere from 12.99% to 22.99%.
4. Shorter repayment time: if you want, and can afford it, you can consider terms which allow you to repay your loan in a shorter period of time.
5. Cash flow: To keep your business’ cash flow positive, you can decide to choose a term that is longer, which will reduce the monthly payment amount. By paying less every month, you will be able to increase cash flow. It will also mean that you will have more flexibility if you choose to expand your business or are considering other opportunities.

Is this a good time for debt consolidation?

The interest rates are historically low. The Bank of Canada has decreased the overnight interest rates from 1.75% to 0.25% in 3 months this year, and the rates are expected to remain low until mid-2023. There has been no time better than now to get a loan.

Source: The Bank of Canada, 2020

The 3 options for debt consolidation

To consolidate your debt, you have three options to choose from:

1. Refinance: you can replace your existing mortgage with a larger mortgage. Think of it as moving your loans over to the lender you will be paying your mortgage to.
2. Second Mortgage: you can register a mortgage behind your first mortgage. Second mortgages are typically interest only, though there are some that are amortized. Whether this is the case depends on the lender. Interest only payments help with your cashflow.
3. HELOC: you can obtain a home equity line of credit (HELOC) which you can think of as a 2nd mortgage in this case, though a HELOC can be a first or second charge. However, instead of paying principal and interest, you would make interest only payments (there may be a required minimum payment with some deals), and you only pay interest on the portion you've borrowed. With a HELOC, you can pay the loan off in full at any time with no penalty and you can borrow what you need. Since the line of credit is secured by your property, the interest rate is much lower than an unsecured line of credit.

Not sure if debt consolidation is for you?

Keep the objective in sight: keeping your cash flow positive without going further into debt. Take the following steps if you’re not sure that debt consolidation is the right answer for you:

If you’re still not sure that debt consolidation is the right answer for you, do two things. First, map out your finances and have a clear understanding of your current liabilities. Second, identify any opportunities for cutting unnecessary spending to help with repaying the loan in time. If you are unable to find ways to increase income or reduce spending, speak to a professional who specializes in consolidating debt. If you own a business, you should speak to a professional who has experience in helping business owners consolidate their business’s debts.

Before you go ahead with a new loan, keep three things in mind:

1. Interest Rate: Check to see that the new loan’s interest rate is not bringing you more liability.
2. Prepayment options: Discuss the terms and penalties regarding early payments.
3. You have options: Keep in mind that banks are not the only ones with debt related services. Other financial institutes and private lenders also offer mortgages.

It's easier to get a mortgage or a second mortgage through a professional. As a borrower, you need to have a clear understanding of your situation. This type of mortgage requires you to own a percentage of a property and have a good credit score. A professional will be able to find you more, and better, options as banks do not often provide second mortgages in small volumes.

At GreenFlow Financial, we can offer diverse options through over 50+ banks, monoline lenders, credit unions, trust companies, and exclusive private investors and lenders, to find an option that best meets your situation.

This is the first of a series of articles for business owners about how to cope and grow during the pandemic.