When dealing with credit card debt, it can be hard to see future financial relief. Credit card consolidation is a tool that can free you of mounting interest and debt. However, consolidation does not eliminate debts; it only combines them into one loan. Therefore, it is crucial to know your financial position before choosing consolidation as a debt management tool.
Table of contents
What Are the Advantages?
Consolidation can sound like a dream come true. The balances on credit card accounts will dissipate, but you will still need to pay the loan. The advantages of consolidation are not in the payment of credit cards. Instead, there are three primary benefits for the consumer:
- Lower interest rate
- Increased credit score
- Easier payment schedule
Consolidation loans will often carry a lower interest rate than many credit card companies. Unfortunately, the lower interest rate will depend on the credit score of the borrower. However, even consumers with lower credit may find more favorable loan rates than their current cards.
When credit card balances are high, it affects your credit rating. Utilization ratios can hurt credit reports. When consumers pay their credit card debt with a loan, the utilization ratio lowers, improving credit scores, sometimes up to 21 points within a few months.
Finally, by combining debt, the consumer only has a single payment to the loan provider. Managing one repayment schedule is typically easier than overseeing several, which can relieve monthly stress and confusion.
Who Will Benefit?
Consolidating credit card balances is the right choice for some people, but not all. While the advantages of combining debt into one monthly payment are enticing, only those who can resist temptation will benefit. Finance always comes down to money management, and no amount of consolidating will resolve poor habits.
Before delving into loan consolidation programs, you need to take a hard look at the way you manage finances. Do you know that you can avoid the urge to use credit cards when you pay off balances? Consolidation programs do not close out your accounts, which is advantageous, but if you cannot control your spending, you will find yourself in more outstanding debt.
Unfortunately, if consumers choose to charge up their accounts again, they are often left with limited options to get out of debt. Many consumers may find only bankruptcy as a possible debt relief option, which can linger on your credit report for years, making it near impossible to secure loans or credit for even minor purchases.
When Should You Use Credit Card Consolidation?
Credit card consolidation is an excellent option for responsible individuals. However, before opting for a consolidation loan, there are a few things to consider to ensure your success:
- Total debt, excluding mortgage
- Cash flow
- Credit score
- Financial plan
Before opting for a credit card loan, you want to review your total existing debt, not counting mortgage payments. If your debt does not exceed 40% of your gross income, then consolidation is something you may want to consider.
Do you find that you can cover your monthly payments every month? If you make enough money to cover your monthly bills without neglecting other essentials, combining your debt into one expense is a good option.
Most experts only suggest using a consolidation loan if your credit score is good enough to qualify for a 0% or low-interest loan. If your loan does not save you on interests, you are often better off paying on the individual accounts.
Finally, before borrowing any money, make sure you have a plan. While consolidating your existing debt can provide relief, it can also lead to greater temptation. The loan creates the opportunity to charge up your credit cards once again, which may put you in a poor financial position for years to come. Make a plan, and avoid falling into a debt spiral.
Example of Using Credit Card Consolidation
To put things into context, imagine you have three cards with a $20,000 total balance. If the interest rate between these cards averages between 22% and 23%, you will need to pay more than $1,000 per month to pay off the balance within two years. With these estimates, you will pay over $5,000 in interest over that timeline.
Now, consider you find a loan with a lower interest rate to cover the credit card debt, say 11%. Assuming the same repayment schedule, you will pay a little over $900 per month over two years, and you will only pay around $2,300 in interest, for a savings of nearly $2,700.
Steps for Using Credit Card Consolidation
If you believe a consolidation loan is right for you, consider your options and follow the appropriate steps. There are five essential steps to take as you move toward a consolidation loan:
- Know the balances, interest rates, due dates and credit terms of all your cards.
- Consider your income and expenses to find an affordable loan option.
- Know your financial goals and how consolidation may affect your future.
- Research consolidation options, like secured and unsecured loans.
- Apply for the best option or program for your situation.
Finding a good or reputable company is about doing your research. Search the internet for company records and reviews. Also, ask around. Your friends and family can be a valuable resource.
Consolidation is not guaranteed to work. Many people fall back into old habits, charging up credit cards and falling into worse financial trouble than before.
It is difficult to find a consolidation loan with bad credit. A secured loan is an option, but it is risky because you use collateral, such as a house or car.