You finally got those credit cards. Your credit card rating was stellar and all of those new credit offers were just too good to pass up. You started spending and got caught up in the euphoria of it. Maybe it was new furniture for your apartment, or a vacation to the Maldives. And when you opened up those new lines of credit, you really didn't pay attention to the high interest rates. And now you have a problem. You're paying a crazy amount in interest; 24.9% on the department store cards that you opened and 18.9% on others. Your lowest interest rate is 14.9%. You open the credit card bills when they arrive each month and you are in shock as to how much you are paying in interest. And there is no way you can pay the recommended amounts to pay off the debt faster; you can only afford the minimal amount due each month, and the interest you will be paying over five years is astronomical.
Debt consolidation
The key reason that consumers consolidate their credit card debt is for the very reasons mentioned above. The interest rates on the existing credit card term is too high and the amount of interest that will be paid over a three- or five-year term is too much to fathom.
With debt consolidation, you can take your high-interest cards and loans and combine them into one loan, often with a lower monthly payment and a lower interest rate. This allows you to pay off your debt faster while incurring less fees along the way.
But there are risks associated with debt consolidation that you need to be aware of before taking that route. It is important that you consider the alternatives.
- Debt settlement
- Debt management plan
- Bankruptcy
This is when you negotiate with your creditors for a reduced payback amount or a lower monthly payment. If you are uncomfortable in negotiating on your own, you can hire a debt consolidation firm to negotiate on your behalf. Often, you will pay a fee to these firms, or they will collect a fee indirectly through the settlement process.
This is when you work with a financial counselor to set a budget and payment plan. Payments are often prioritized toward cards and loans with higher interest rates, applying any extra funds to those creditors first, while ensuring all other creditors still receive a minimum payment. Your financial counselor will negotiate with your creditors on your behalf to lower your payment and fees, and your payments are made via a debt management fund that you pay into each month.
For some, bankruptcy is the appropriate course of action. If you are at risk of losing your home, your car is subject to repossession, or your landlord has threatened to evict you, bankruptcy might be the right choice. You may also want to consider this option should you be subject to a lawsuit or expect to receive property in the near term. Keep in mind though that a bankruptcy will remain on your credit report for a long time – seven to ten years – significantly hindering future financial decisions that you may wish to make.
If debt settlement, a debt management plan, or bankruptcy are not the right options for you, you may wish to consider a debt consolidation loan.
Debt consolidation loan
Generally, when people talk about debt consolidation, they are referring to a loan option. This is a low-interest loan that is used to pay off all of your high-interest credit cards and loans, allowing you to make one payment per month, usually for a reduced payment each month (but not a reduced payback).
Because your payment is lower and you are still responsible for all of your debt, it is likely that your loan repayment period will be longer. But the benefit is that your monthly financial situation is now easier to bear.
Another loan option is the debt settlement option mentioned previously. We want to reiterate this alternative to make sure it is clear to you that in this case, your payback terms have been modified and you may be absolved of some of the debt that you had.
In these situations, the settlement is reported to the credit bureaus with an indication that the account was either settled or settled in full for a lower balance. This sends a flag to the bureaus that you did not pay the agreed upon amount, and it will have a negative impact on your credit score, even if you made your payments on time.
Credit card debt consolidation
When deciding to take out a debt consolidation loan, it is usually for high interest credit cards. However, there are other ways to help alleviate the high credit card fees. Many consumers will look to negotiate their card interest rate with the card holding company. Often, if your credit score is favorable and your account is in good standing (you pay on time every month), a creditor will allow you to negotiate a lower interest rate. Often the creditor does this by offering you one of their current promotions.
Another option without taking out a loan is to look into balance transfer opportunities between your cards. If you haven't maximized the utilization on one of your cards and that creditor offers a balance transfer promotion, this is definitely something to consider.
Often, creditors will offer 0% interest for six months or even one year for balance transfers, for just a small transfer fee which is often far less than the monthly interest you are paying. And, there are plenty of companies that will give you 0% interest to begin (which may increase later) but this serves as a nice enticement for many people to open accounts.
Debt consolidation loans – bad credit
Before you pursue any debt consolidation options, it is important to understand what could happen to your credit score as a result. If you are moving multiple balances to one lower interest loan with a lower monthly payment, even if that overall loan term is longer, this can actually help to improve your credit score. In this scenario, you are keeping all of the debt that you have accrued, but paying it in a different way.
Also, in the above scenario, you now have just one monthly payment to worry about, which means less risk of inadvertently missing a payment due date. And the more you make your payments on time each and every other month, the more your credit score benefits.
However, if you pursue a debt consolidation loan that offers some sort of debt forgiveness or reduced payback amount, this means that someone somewhere is going to take a penalty of some kind. Usually, this means that the creditor is not going to get the full amount of interest that they had billed you, as the account has been settled. And when this happens, you will face a penalty as well, generally in the way of a derogatory hit to your credit rating.
Finally, when taking out a debt consolidation loan, regardless of which of the above approaches is taken, you could find yourself in a situation of taking on even more debt with those newly freed up credit card balances. While in some instances you will be required to close the credit card accounts that are tied to the consolidation, this is not always the case, and whether or not you need to do this is tied directly to your personal situation.
Credit management is all about responsibility, education, and making good choices. By taking the time to understand your credit score, and by having a keen eye on your monthly budget and card utilization, you will better position yourself to make smart decisions on your monthly spending habits.
Does debt consolidation hurt your credit score?
Getting more credit can actually help your score because you are bringing up your credit utilization - which is the amount of debt you have vs. how much you have available. On the other hand, if you carry high balances on those cards / credits then your score may go down. A good example is putting all your balances on one credit card. Although the remainder of your cards may be paid off, you would be utilizing close to the limit on the one and this will impact your score.Does debt consolidation loans hurt your credit?
Taking a personal debt consolidation loan could increase your score because your credit utilization ratio would go down. In order for this to work correctly, you would need to leave your credit card accounts open even after you pay them off. Although, be mindful that if you have a history of bad debt, your credit rating could potentially go down considering the credit bureaus may suspect you could easily acculumulate more debt quickly.Top Debt Consolidation Companies of 2019
- National Debt Relief
- Lending Tree
- CuraDebt
- Lending Club
- American Debt Enders
- CareOne Debt Relief Services
- Avant
- OneMain Financial
- Debt Consolidation Care
Should You Consolidate?
There are a few options to consider before you jump into debt consolidation. Speak to a credit counselor first and see where you stand prior to applying for a loan. For some people, jumping into consolidation without a plan going forward may work against them. Borrowing more money to pay off current debts without a clear plan or strategy may be detrimental to you and your finances. A debt counselor could help you negotiate terms with your banks. The most important thing is to reduce your overall debt so make sure you have a plan in order to do that, with or without, a debt consolidation loan.
