Why Consolidate Credit Card Debt and 5 Essential Tips to Do it Properly?
By Christine Yaged
If you’re drowning in credit card debt and find the balances you owe spread out over several cards with various interest rates, things can start to become overwhelming quickly. In my experience, this is when people often start to consider consolidating their debt in hopes of finally paying it off.
Here’s how debt consolidation works: Once your credit card debts are consolidated into a single loan, you begin making one payment per month towards your loan and those funds are distributed accordingly to pay off each of your credit card debts. This process simplifies your life and can help lower your total interest rates if you choose wisely.
Consulting a non-profit credit counselor is a great first step to deciding which debt consolidation plan, if any, is right for you. But in the meantime, here are five tips to help you consolidate your debt wisely.
1. Learn your credit history
Your first priority is to familiarize yourself with your credit report and credit score. Even if you think you know, check again, because errors are more common than you might think and could prevent you from receiving the help you need, so if you find an error, dispute it quickly, as it can take months to get an inaccurate mark removed from your credit report.
To get yours, you can request free annual credit reports from all three of the major credit reporting agencies: TransUnion, Experian, and Equifax.
2. Choose your consolidation route
After getting a good grasp on where your credit stands, there are three basic options to consider when consolidating credit card debt: consolidation credit cards, personal loans, and debt management plans – each having its own drawbacks, benefits and requirements to consider. Let’s explore each one quickly:
Debt Consolidation Credit Cards
Moving your debt onto one credit card is a popular consolidation option. It may seem counterintuitive at first, replacing credit card debt with more credit card debt, but if you can find a consolidation card with an interest rate lower than the rates on your current cards, you may be able to save money in the long run by sticking with a disciplined payment plan.
Debt Consolidation with Personal Loans
Interest rates on credit cards can vary over time and some will even have separate rates for purchases and balance transfers. Personal loans are often much simpler than that and usually offer a fixed interest rate.
Your bank or credit union may be able to issue the loan for you, and if you meet the requirements, this may be your best option. Generally speaking, going to a third party lender is something to consider if your bank cannot give you help at a reasonable price. And remember that the better your credit score, the higher your odds of landing a low interest rate.
The world of for-profit debt companies is full of fraud, so be wary. If you go to a private lender, check them out using the Better Business Bureau before completing an application and applying. The BBB will be able to warn you any potentially fraudulent companies. The State Attorney General’s Office or the Department of Banking/Financial Regulation are also good resources to use when vetting a company you are considering working with.
If the first two options aren’t viable for you, or you feel like you need a more structured form of debt assistance, then debt consolidation company or a credit counseling agency may be able to help you. They can help you enroll in a structured plan to eliminate debt.
A debt management plan means handing your consolidation over to a credit counseling agency to management on your behalf. These plans usually happen over the course of three to five years. You’ll make a monthly payment to them and they will make sure each of your credit cards gets paid appropriately. If you’re lucky, your credit lenders may lower your interest rates once they see that you are enrolled in a debt management plan.
3. Crunch the numbers
Nothing in life is free, and that includes most debt assistance. There may be hidden fees and challenges with debt consolidation. Your safest bet is to do your research before you commit to anything. How long will your plan take to eliminate your debt? Will the costs associated with your consolidation plan outweigh your savings? These are concerns that credit counseling will be able to help you with.
Two fees to watch out for are balance transfer fees on credit cards, and origination fees on personal loans. While it’s difficult to avoid fees entirely through this process, do your homework on each one. Not every plan has an enormous starter fee, especially if you have decent credit.
Take into consideration the time frame on interest rates. Many rates are actually promotional and skyrocket after their expiration date. So be on top of your schedule and make sure you’re paying off your debt in a timely manner to get the best benefits of low interest rates. Use your consolidation payments as an opportunity to build up your positive credit history.
4. Remember your credit score
With everything going on once the ball gets rolling with your credit card consolidation, it can be easy to forget about the ways your credit score may be affected. In short, your score will definitely be affected, but how it’s affected depends on the strategy you end up choosing. The most notable effect will likely be your credit utilization rate, which comprises 30% of your credit score.
Credit utilization is your credit usage compared to your total limit. So if you have two credit cards with $1,000 limits, your total limit is $2,000. If you routinely spend about $1,000 then your utilization rate is 50%, regardless of whether that money was spent all on one card or spread out over both. The ideal credit utilization rate usually hovers somewhere between 10 and 20%.
How does this affect debt consolidation?
Well for starters, you may not want to close out your old credit cards, as doing so will lower your total “available” credit limit and thus increase your utilization rate. If you go the route of a debt management plan, you might have little control over this, as creditors may suspend or close accounts on their own. A silver lining with some creditors is that once your plan has been completed and you begin to build your finances back up, some creditors may decide to re-establish your credit based on your established payment history and newfound debt-free status.
In addition, applying for a consolidation credit card can result in a hard inquiry on your credit report, which can affect your score, and being approved for a consolidation card may lower the age of your credit history. It is up to you to decide whether these setbacks are outweighed by the benefits of consolidating your debt.
5. Stick with it
Your debt consolidation plan is only going to be as successful as you make it. There is no instant cure for credit card debt. To truly become debt-free, stick with your chosen, researched plan and get started on the right foot. Make sure you get your payments in on time and avoid running up new debt while you’re still paying off your old debts.