Consolidating card debts can feel daunting. It's a new kind of debt you may not have accessed before, so let's look at where to begin and how to measure the benefits.
What are the best ways to consolidate debt?
There are several debt consolidation options like Balance transfers, debt consolidation loans, and home equity loans for consolidating credit card debt. Not all of them are for everybody, but none of them require excellent credit. Balance transfers and debt consolidation loans are the most common, but let's look at several, one by one.
1. Balance transfer credit card
If you have good credit, there's a good chance that you can transfer the balances of several credit cards to a new balance transfer credit card at a lower interest rate, often with a 0% APR for an introductory period. If you qualify, a credit card balance transfer can be a quick solution offering immediate relief.
2. Credit card debt consolidation loans/ personal loans
A debt consolidation loan is a type of personal loan available from banks, credit unions, and online lenders. With this solution, you'll take the loan's lump sum and use it to pay off your cards. Then, instead of managing always-shifting credit card payments every month, you'll only have the loan's monthly payment - at an annual percentage rate (or APR) lower than you're paying on your cards. The loan's lower APR is the real cost-saver here. If you can't find a consolidation loan with a lower APR than your credit cards, then think twice about this approach.
3. Home equity loan
If you own a home and have enough equity to qualify, you can use a home equity loan or a home equity line of credit (also known as a HELOC) to pay off your credit cards or other debts. Talk to your mortgage provider and compare their terms with those of other financial institutions. Like personal or consolidation loans, simplified payments under a lower APR are a big bonus here.
4. Debt management plan
If transfers and loans aren't available, or if you just don't want a new loan, consider working with a credit counseling agency that can set up a debt management plan. Credit counselors often negotiate a debt settlement on your behalf and then take payments from you to pay your creditors. However, unscrupulous organizations abound in this field, aiming to profit off a deal with your creditors. Look for nonprofit credit counseling agencies and survey reviews from previous users.
What are the benefits of consolidating credit card debt?
If you have a lot of debt you're trying to get rid of, debt consolidation can offer a clear way forward, with more agreeable repayment terms. No matter which method you choose, here are five benefits that apply across the board:
1. Streamlined payments
Instead of tracking multiple due dates each month, consolidate your debts into a single monthly payment, with one monthly due date. This saves you time, and it simplifies budgeting. With the same monthly payment every month, it's easier to set aside enough funds.
2. Lower interest rates
Personal loans and debt consolidation loans are frequently available at lower APRs than most credit cards. By paying off your high-interest cards and shifting the debt to a loan with a lower fixed interest rate, your savings could be substantial, especially in the long term.
3. Improved credit score
A debt consolidation loan may lower your credit score. It's behavior that credit reporting agencies view as positive and responsible, often rewarding you with a score boost. If you make regular on-time payments over the loan term, you'll build a positive credit history, which can improve your score, too.
4. Fixed payments
A debt consolidation loan is easier to track and easier to stay on schedule, with regular fixed payments every month. Usually, a debt consolidation loan offers a schedule that gives you a clear end to your debt payoffs, which can help focus your efforts and plot a clear path ahead.
5. Lower payments
By consolidating debt, your monthly payment will lower because you'll have more time to pay it off over the loan's extended term. However, even with a low-interest rate, you could end up paying more interest over the total life of the loan.
Is consolidating credit cards bad?
Does consolidating debt ruin your credit? Getting a debt consolidation loan can help lower your monthly payments, but it can also trigger a temporary dip in your score. Always look for loans or balance transfer cards with low or zero origination fees and balance transfer fees. And before diving, make sure you can afford the loan's proposed repayments.
Here are three ways consolidating debt can affect your credit. Some are good, some are bad.
1. Hard inquiries on your credit:
When you apply for a debt consolidation loan, the lender will perform a hard inquiry on your credit history. This usually takes down your credit score by around 10 points, and it usually stands for about a year after your credit check.
2. Change in credit utilization:
Lowering your credit utilization ratio can be a good thing for your credit score. Credit utilization measures how much of your total credit limit you're actively using. If you pay off your cards through consolidation, you'll make more card credit available, your credit utilization ratio will go down, and your credit score is likely to go up.
3. Average age of accounts may drop:
Your credit score fluctuates depending on how long your credit cards and loans have been open. If you consolidate and pay off your cards, consider keeping them open with a zero balance. If might feel good to close old credit card accounts, but the average age of your accounts will go down, taking a toll on your FICO score.
When is it a good idea to consolidate credit card debt?
Consolidation can be a wise financial decision, depending on your financial situation. Here are four financial scenarios where consolidation makes sense:
- Your monthly debt payments exceed 50% of your gross income.
- Your credit is still good enough to get a low-interest debt consolidation loan or a 0% balance transfer credit card.
- You have a stable cash flow to pay off a new consolidation loan regularly.
- You'll be able to pay off a consolidation loan within 5 years.
Why Bright Money?
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Bright Plan: This tool helps you create a budget, track your spending, and set financial goals. It gives you tips and recommendations based on your financial situation to help you make better decisions and improve your credit.
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Bright Money combines technology with expert advice to help you take control of your finances and build a brighter future.
Conclusion
Consolidating credit card debt can be a strategic move to manage overwhelming debt more effectively. Whether through balance transfers, consolidation loans, or other methods, it offers streamlined payments, lower interest rates, and potential credit score improvement. However, it's crucial to assess individual circumstances and weigh the benefits against potential drawbacks before proceeding.
FAQs
1. Is consolidating credit cards bad for your credit score?
Consolidating debt can initially lower your credit score due to hard inquiries and changes in credit utilization. However, it can ultimately improve your score by reducing overall debt and improving payment consistency.
2. How does debt consolidation affect credit card utilization?
Debt consolidation can lower credit card utilization by paying off multiple cards, making more credit available. A lower utilization ratio typically positively impacts credit scores.
3. When is consolidating credit card debt a good idea?
Consolidation is beneficial when monthly payments exceed income, one qualifies for low-interest consolidation options, has stable cash flow, and can repay the loan within a reasonable timeframe.
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