How to Consolidate Debt Without Hurting Your Credit Score
If your debt is out of hand, you’re not alone. America’s household debt is steadily increasing, up to a record $16 trillion in 2022.
Credit cards are a big part of it. Credit card debt increased 13% between mid-2021 and 2022, the biggest 12-month hike since 1999, to reach $890 billion.
You know how it happens – you’re short on cash, so you charge groceries or gas, figuring you’ll catch up later. But you never really catch up and the balance never goes down … so what do you do?
Credit card debt consolidation is a good way to get a handle on monthly payments and decrease debt, but it must be done right if you want to do it without hurting your credit. Bad credit can have long-term effects on your ability to borrow for a house or car. It also can affect your insurance premiums, even getting an apartment or job.
The most common forms of debt consolidation mean taking on more debt in the form of a loan or balance transfer, so it can be a slippery slope as far as credit score goes. Alternative debt relief options include debt management, debt settlement or bankruptcy.
Finding the best way to consolidate credit card debt without hurting your credit means understanding your finances, as well as the options.
What Is Debt Consolidation?
Consolidating your debts is just what it sounds like – you consolidate your unsecured debt into one big debt and pay that off with one monthly payment. When done right, it will reduce the interest on your debt and make it easier to pay down debt and strengthen your credit.
Debt consolidation is a good option if you have a lot of high-interest credit cards. Credit card debt consolidation can make it easier to keep track of what you owe, make payments on time, lower your interest rate (thereby lowering monthly payments) and more.
Some of the most common forms of debt consolidation are personal loans, credit card balance transfers, home equity loans or lines of credit, or borrowing from a 401(k). All combine debt payments into one monthly bill and, ideally, have lower interest rates than the debt you’re consolidating.
Debt consolidation only works if it makes it easier and less costly to pay your creditors. It should not add to your debt load. It should be a tool to reduce it.
Does Credit Card Consolidation Hurt Your Credit?
You may ask “How does debt consolidation hurt your credit score?” After all, you are making a move toward getting a handle on your debt, so it should help it, right?
Eventually, it should (that part is in your hands). But it may hurt your credit before it helps it.
The factors that affect your credit score are:
- Payment history – 35%
- Credit utilization – 30%
- Longevity of credit accounts – 15%
- Credit applications – 10%
- Credit mix – 10%
All of these come into play – some good, some bad – when you take out a debt consolidation loan, open a transfer card or take out a home equity loan or line of credit. Here’s how:
Credit applications: You are taking on new debt when you consolidate your credit cards. This means a hard pull on your credit report by your new creditor. Every hard pull lowers your credit score a little bit.
Longevity of accounts: If you close any credit accounts, it will lower your score. The longer you’ve had an account, the more points it adds. The newer your accounts are, the less good it does for your score.
Credit utilization: This can help your credit or hurt it – it’s up to you. If you take on more debt to pay off credit cards, but then run up more debt on the cards, the amount of credit you have vs. what your limits are will go up. A 30% credit utilization or less is ideal for a good score.
Debt Consolidation Can Help Your Credit
Credit card consolidation can help your credit in the long run.
On-time payments have the most credit score impact. Debt consolidation should lower and streamline monthly payments, meaning you can make them on time.
You will also increase credit utilization if you don’t take on more credit, but instead focus on paying down what you have.
If you take out a loan, it will vary your credit mix, another positive factor.
Should You Consolidate Your Credit Card Debt?
The interest rates on your credit cards are likely pretty high. If you haven’t already, take a look at your monthly statements. Federal law requires that all credit card statements show how long it’ll take you to pay off the balance if you only pay minimums, and what amount you will end up paying. If you pay 25% interest or more, it can take more than 15 years to pay off a balance of $4,000, and nearly triple what you owe.
That’s an eye-opener. And this assumes you don’t keep using the card and maxing it out.
In the short-term, look at what you paid in monthly interest on that card. It could be $90 or more. That’s a big purchase you’d probably have to think twice about making, but you could be paying it every month on a high-interest credit card.
If you have more than one credit card, it can be hard to keep track of when payments are due and how much they will be. This can cause late payments.
The biggest reasons to consolidate your credit card debt are to lower interest rates, which lowers monthly payments, as well as to streamline payments.
Any option you choose should do these two things.
How to Decide Which Form of Debt Consolidation Is Best for You
The best way to consolidate your debt is whatever way makes your financial situation better. No one but you can determine that, and it means taking into account your monthly budget, your credit score, the amount of debt you have, and why you are in debt.
For instance, if you have a low credit score, you likely won’t qualify for a loan that has low interest and fees. You must weigh the cost of the loan against the cost of your current debt. If you take out a balance transfer card but can’t pay the transferred debt off before the low or zero rate increases (usually 12-18 months), then it won’t help you.
If you have bad financial habits, or don’t budget, then you need to start from the beginning and figure out ways to change your money narrative. Taking on debt consolidation before you have a handle on why you’re in debt and can’t get out, will often make things worse, as you repeat the mistakes that got you there, only on a bigger scale.
On the other hand, if you’re committed and focused, you can try to do it yourself. DIY debt consolidation requires having a realistic and accurate monthly budget and sticking to it. That choice also means no longer using credit cards and having enough extra cash flow to apply to their balances. It means having the confidence to call your creditors and negotiate lower interest rates.
It’s not for everyone. For those who can’t do it themselves, the most common forms of debt consolidation are:
- Personal loan – A low-interest bank loan that you’d then use to pay off your credit card debt. Personal loans for debt consolidation usually requires a good credit score.
- Credit card balance transfer – A low or no-interest credit card that you can transfer your other credit card balances to; interest usually increases after 12-18 months. Usually requires a good credit score.
- Debt consolidation loan – A loan specifically for debt consolidation; the lender may even send the payment to your creditors, rather than have you do it. Usually requires a good credit score.
- Home equity loan or line of credit – A “second mortgage” or a line of credit, using your home’s equity, with a much lower interest rate than credit cards and, generally, other types of loans. But you are also putting your home on the line if you can’t pay. A home equity loan is a set amount of money; a line of credit (HELOC) is a revolving credit account. Interest used to be tax-deductible, but it no longer is if you’re using it to pay off credit cards. Even with a lot of equity in a home, your credit score will have an impact on your interest rate, fees and other factors.
- Borrowing from 401k loan – Rules vary, depending on your plan, but borrowing from your 401k is almost always easier than taking out another kind of loan. You are borrowing from yourself, and your payments will be deducted from your paycheck. Credit score doesn’t matter, but there may be tax implications and you also are using money that could be helping build your retirement account.
Beware of High-Interest Consolidation Loans and Scams
Avoiding loan scams is key when you’re shopping for debt consolidation options. Avoid anything with high interest or excess fees. Don’t believe promises that you can pay pennies on what you owe or pressure you into signing up. Check the Better Business Bureau or Federal Trade Commission for lists of scammers.
Alternatives to Debt Consolidation
If you already have bad credit, are living paycheck to paycheck – or both – debt consolidation may not be right for you. The lower your credit score, the fewer options that make financial sense are available.
There are alternatives to get rid of debt, though. Some will ultimately help your credit score, others, while solving your immediate debt problem, may damage it for years to come.
Debt relief options that go further than debt consolidation include:
- Debt management – Done through a nonprofit credit counseling agency, it reduces interest rates on your credit card debt to around 8%. It isn’t a loan. You make one monthly payment to the agency, and they pay down your credit cards. It usually takes 3-5 years to eliminate the debt and will help your credit score in the long run because payments will be made on time and your debt will decrease.
- Nonprofit debt settlement – Also called credit card debt forgiveness, if you qualify, you pay 50%-60% of what you owe in 36 months, with 0% interest charged. It’s a relatively new program, so many banks aren’t on board yet, which may make a program that fits hard to find.
- Debt settlement – Through for-profit companies, you pay less than what you owe after the company negotiates with your creditors. It usually takes 2-3 years, and can mean high fees and damage to your credit, since you don’t pay credit cards during the negotiating period. This negative stays on your credit report for seven years.
- Bankruptcy – This is the nuclear option. It will eliminate unsecured debt but stays on your credit report 7-10 years and lowers your credit score by 100-200 points.
Credit Counseling Debt Relief Option
Before deciding on any debt consolidation or debt relief option, try nonprofit credit counseling. It’s free, and counselors are required by law to lay out all options, not sell you a product. Counselors review your budget and help you decide what will work best for you. Check out the National Foundation for Credit Counseling to find an accredited credit counseling agency.
Long-Term Debt Management and Financial Habits
Getting out of debt and building good credit in the long term takes more than just one debt consolidation solution. While the solution may help the immediate problem, without a solid financial foundation, you’ll be back in the debt vortex before long.
Having and sticking to a budget and learning good financial habits are the best ways to maintain good credit.
Easier said than done, right? That’s where a debt management plan, can help. Anyone with high-interest credit card debt would benefit from a DMP.
If you’re concerned about your credit score, it’s not a factor to enroll. If you have enough income to pay the expenses, including the amount needed to pay off your credit card debt – which a credit counselor helps you work out – you are qualified.
The counselor will calculate how much of a monthly payment you’ll need to eliminate your credit card debt in the 3–5-year DMP period, and that’s what you’ll pay, along with a small monthly fee.
As your credit card payments are made on time, and your balances decrease, your credit score will improve.
If you’re looking for a way to lower your debt without hurting your credit score, a debt management plan is likely a good solution.
About The Author
Maureen Milliken has been writing about finance, banking, investment, entrepreneurship, real estate and other related topics for more than 30 years. She started as the “Business Beat” columnist for the now-defunct Haverhill (Mass.) Gazette and currently is one of the hosts of the Mainebiz business-focused podcast, “The Day that Changed Everything” in addition to her daily writing. She also is is the author of three mystery novels and two nonfiction books.
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