Credit card debt can quickly overwhelm you. If this is you, don’t worry, you have options. Before you jump into a debt consolidation plan, know the pros and cons. No matter how many offers you receive for consolidation, do your research. They each have their pros and cons. Your situation determines which option works best for you.
Consolidating your credit cards means placing them all in one loan. You may choose a new credit card, installment loan, or debt management plan. The bottom line is the same for each option. You have one monthly payment. But, the interest rates, terms, and costs differ. We’ll discuss how you know what’s right for you below.
Know Your Credit Score
Before you consolidate credit card debt, know your credit score. This is different than your credit history. Trans Union, Equifax, and Experian each provide you with 1 free credit report per year. This helps you keep track of your credit history. You can report errors and help improve your credit score by checking the report’s accuracy.
These reports don’t provide your credit score, though. Luckily, many credit card companies and banks provide free access to your credit score. Before you choose a consolidation method, check your score. It will affect which choice is right for you.
- Great credit – If you have a high score, you may benefit from a balance transfer. You apply for a new credit card with a 0% APR (or at least a low APR). Once approved, you transfer your existing balances to the new card. You then have one payment and a much lower interest rate.
- Good/Fair credit – Without a high credit score, you may not get favorable terms on a credit card. You might get approved, but it might not be for the terms you need. You may receive a lower available balance or higher interest rate. In this case, look for personal loans or home equity loans. These installment loans can pay off your credit cards. You then have one monthly payment. Installment loan usually have lower interest rates than credit cards (except 0% credit cards).
- Bad credit – If you don’t qualify for a credit card or installment loan, you may need a debt management plan. Debt consolidation companies can negotiate your debt for you. They work with your creditors to lower your balances and/or interest rates. You then make one payment to the debt management company. They then pay your creditors for you.
Each person will have a different method for paying off his or her credit card debt.
For example, someone with great credit may benefit from a new credit card with a 0% APR. But, there’s a catch. You must be able to pay off the full balance before the rate increases. Otherwise, you could end up paying more for the debt. You must read the fine print. Know when the rate increases. You should also know how much it would increase.
Even a person with a great credit score may not benefit from a new credit card. If they can’t pay the balance off fast enough, it may cost more in the end. In this case, they may want to explore other options, including an installment loan. This usually provides a lower interest rate than any credit card.
What’s it Cost?
Debt consolidation doesn’t come free. Each method costs money. The lender and option you choose determines just how much.
- Credit cards – Even if you are lucky enough to secure a 0% APR, check out the fees. Many companies charge a balance transfer free. Let’s say the fee is 3%. You want to transfer $10,000 over to the card. It will cost you $300. You’ll like save more than $300 consolidating your debt, but make sure. Again, pay close attention to the expiration date of the APR too. If you can’t pay the debt off in time, you should calculate the cost of the future interest rate plus the balance transfer free. The cost may not be worth it in the end.
- Installment loans – Banks often charge origination fees and other closing costs on these loans. Make sure you ask your bank about all fees charged. Get proof of them in writing. This way you can decide if the loan saves you money. Compare the total cost of the installment loan, interest included, with the payments you currently make. If there isn’t a large savings, it may not be worth it.
- Home equity loans – Banks also charge closing fees and origination fees on home equity loans. You’ll receive a Loan Estimate from the lender within 3 business days of applying. Review it carefully. Total up the fees. Look at the APR. The Loan Estimate also tells you the total cost of the loan if you carry it full term. Compare this to the total your credit card debt would cost.
- Debt management plans – Using a non-profit agency will save you the most money. But, you’ll still pay fees. The average is around $75 for account set up and around $50 per month for account maintenance. Consider the cost when looking at how much the DMP may save you on interest. Make sure it’s in your best interest to use this option.
What’s Your Capability?
A large factor is how capable you are of paying off the loan. Each option above has a limit. You must be committed to that plan. For example, a 0% APR credit card expires over time. You can still have an outstanding balance, but you start making interest payments. If the interest rate increases higher than your current rate, does it make sense? It depends on your plan.
Look at the big picture. How long will it take you to pay off the debt? If you choose the credit card option, divide the balance in equal installments based on the term of the 0% APR. For example, let’s say you have a $10,000 balance. You snagged a 0% APR for the first 24 months. After that, the rate increases to 15.9%. Paying off the full balance means before the rate increase means paying $416 per month. If you can’t afford it, you may want another option.
Installment and home equity loans have fixed interest rates for the loan’s term. Make sure you can comfortably afford the payment. The lender will determine your debt ratio and make sure you can afford the loan. But only you know realistically what you can afford. Making late payments hurts your credit. Skipping payments can put you in default. This costs you more in the end. Make sure you can afford the payments easily.
Defaulting on a debt management plan only hurts your future credit as well. Let’s say the management company puts you on a 5-year plan. Make sure you can afford the agreed upon payment. While you are on the plan, your creditors will likely freeze your credit accounts. If you default, your creditors may not grant access to your accounts. If they close them, this cause your credit score to drop even more.
Know the Impact to Your Credit Score
Last, you should know how your choice affects your credit score. Using the first step from above, you should know your current score. Knowing how the debt consolidation plan affects your score may affect your decision.
- Balance transfer credit card – A new credit card may decrease your credit score, but only slightly. The hard inquiry on your credit dings it slightly. Then you have the newly available credit. This helps your score until you use it up. How much of the available credit will you use? If you’ll max it out, you increase your utilization rate. This lowers your credit score. If you have great credit, it may not matter. If you have borderline credit, though, consider your other options.
- Installment or home equity loan – The hard inquiry on your credit report dings your score for any new loan. But, an installment or home equity loan doesn’t affect your utilization rate. Your score may drop slightly after opening the new loan, but temporarily. This is due to the newness of the account. If you close your credit cards after paying them off with this loan, you could further the damage to your credit score. Ideally, you should keep your credit cards open but unused. This will have the best impact on your credits core.
- Debt management plan – Borrowers using the DMP usually have lower credit scores. The plan may help or hurt your score. It depends on the situation. Your creditors may mark your credit with charge-offs if they lower your balance due. This negatively affects your credit score. But, making timely payments can help increase it. What your creditors do with your credit cards also matter. If they close them, your score may decrease. If they just freeze them, you may not see as large of a negative effect.
Knowing your credit score going into the credit card debt consolidation can help you make the right decision. If you have a high score already, you have more options. If your score is borderline, you’ll want to weigh the pros and cons of each option. A 0% APR credit card may not be an option. You should then look at how an installment loan or debt management plan will affect it. Think long-term to determine what you should do.
This is a very personal decision. No matter your choice, it will affect your credit score one way or another. Make sure the option you choose is affordable. Timely payments can only help your credit score in the end. Look at the total cost of each option and choose wisely. There’s no reason to overpay for debt consolidation. Look at the big picture and decide what works best for you. Then make sure you stick to the plan so your hard work pays off.Click to See the Latest Mortgage Rates»