Debt Consolidation Loans For Bad Credit Do Exist in Canada, But They Are Rarely Worth It

By Julien Brault, founder of MooseMoney.

If you have bad credit and you are searching for a debt consolidation loan in Canada, you need to understand one core reality. The loans that exist for borrowers with poor credit scores almost always carry interest rates that are equal to or higher than the debts they are meant to replace. That defeats the entire purpose of consolidation, which is to reduce your overall interest cost and simplify repayment. 

Richard Goyder, Chief Credit Officer at Neo Financial, put it bluntly. "Credit consolidation loans are very hard to do successfully, since people seeking them are looking for an overall lower rate. And the fact that they are seeking those types of loans is a strong signal that they are a credit risk. That said, this is something we are looking to develop at Neo in the future," said Goyder.

That signal Goyder describes is a catch-22. The very act of needing a consolidation loan tells lenders you are struggling, and lenders respond by raising the price of the loan or declining the application entirely. Banks and credit unions in Canada typically require a credit score above 650 for an unsecured personal loan at a competitive rate. If your score sits below that threshold, you will likely be pushed toward secured lending products that require collateral, or toward alternative lenders whose annual interest rates can climb to 35% or higher in some cases. At those rates, you will pay more over the life of the consolidation loan than you would have paid by continuing to manage your existing debts separately.

Why Most Bad-Credit Consolidation Loans Cost More Than They Save

The Government of Canada's own guidance on debt consolidation warns that borrowers should check whether a consolidation product carries a higher interest rate than their current debts, because if it does, the consolidation will actually increase total debt. This warning applies doubly to Canadians with poor credit.

Here is how the numbers typically break down. The average Canadian credit card charges interest between 19.99% and 29.99%. A borrower with good credit might qualify for a consolidation loan at 10% to 15%, which creates meaningful savings. A borrower with a credit score below 650, however, will often be quoted rates of 25% to 35%, the maximum interest rate in Canada, from alternative lenders and finance companies. At those levels, there is no interest savings at all. You are simply moving debt from one expensive product to another expensive product while potentially extending the repayment timeline and paying more in total interest.

There is also a behavioural danger that applies regardless of your credit score. If you consolidate credit card balances into a single loan but keep your credit cards open, you can end up with both the consolidation loan and new credit card debt. That said, many lenders now require borrowers to close their credit cards as a condition of the consolidation loan for exactly this reason.

Consolidate Before You Ruin Your Credit Score

The most effective step a Canadian with bad credit can take is to act before the situation gets worse. Goyder stressed this point directly. "If you can tell that you're not going to be able to afford the credit that you have the sooner you act the better, because when you start missing payments, your credit score is going to go down and it's going to be harder for you to get a consolidation loan," said Goyder.

The first call should go to your existing lenders. Most Canadians skip this step entirely, but it is often the most productive one. "If you can see that you're getting into financial difficulties, that's the moment to get in touch with your lender. Lenders don't want you to get into trouble, because then they're going to lose money, too. So, if you get in touch with your lender and ask them to convert your debt into something with a lower interest rate, the lender is always going to try to help you out with a solution," said Goyder.

Your lender may agree to lower your interest rate, extend your repayment period, or restructure your debt into a more manageable format. This approach costs nothing to attempt, and it avoids the credit inquiry that comes with applying for a new loan. If this does not work, and that the only consolidation loans offered to you might make your financial situation even worse, you might want to consider a consumer proposal.