Debt consolidation offers consumers a way to save money on interest, qualify for a single monthly debt payment, and pay down their debt more quickly than would be possible without consolidation. You may be wondering about the best way to consolidate debt without hurting credit scores.
Here at Leaders Credit Union, we believe that debt consolidation can be a great solution for anybody who’s worried about debt repayment. There are several ways to consolidate your debt, some of which have a larger impact on your credit than others. Here’s what you need to know to make an informed decision about debt consolidation with five strategies to try.
What Steps Should Someone Take Before Deciding to Consolidate Their Debt?
Debt consolidation can be useful for anybody looking to pay their debt quickly. Debt consolidation can help you improve your credit score and get out of debt. Here are the steps to take before you decide to consolidate your debt.
Determine Why You Have Debt
The first step is to look at why you have accumulated debt in the first place. There could be several reasons. For example, you might have debt because you’ve been spending more than you earn or because you had unexpected expenses.
If overspending has been an issue, you’ll need to create a budget and commit to spending within your means before you move ahead with debt consolidation. If you’re in debt only because you’ve had an emergency or some other unexpected expenses and you have a budget, debt consolidation could be a good option for you.
Review Your Interest Rates and Contact Creditors
Applying for a new credit card or a debt consolidation loan will have some impact on your credit score, albeit a minor impact. That said, you should start by contacting your creditors and seeing if you can reduce your interest rate without consolidation.
If your financial circumstances have improved since you got approved for a credit card, and you’ve made on-time monthly payments, your credit card company may be willing to reassess your credit and lower your interest rate. Assuming they are, you may not need debt consolidation to reduce your monthly payments.
Research Lenders and/or Credit Cards
What if you can’t reduce your interest rates directly with your creditors or you want the peace of mind of having only one debt payment per month? If that’s the case, it’s time to research financial institutions and credit card companies to narrow your options and find those that are best suited to your needs.
Many lenders have a personal loan option where the funds can be used to pay down credit card debt. The loan amount available should be enough for you to consolidate any debts with high-interest rates. Your lender should have information about the range of loan amounts available. Keep in mind that debt consolidation loan options may include a personal loan, a home equity loan, cash-out refinance, or a home equity line of credit (HELOC).
With credit cards, you should look at balance transfer fees. It’s common for balance transfer cards to come with an introductory APR of 0%, but there may be limitations. One of the most common is that the introductory rate applies only to balance transfers and not to new purchases.
Are There Any Risks Associated with Debt Consolidation?
There are some risks associated with debt consolidation that you should consider before you begin the process of consolidating your debt.
- You may have upfront costs. If you opt for a debt consolidation loan, you should expect to pay an application fee and closing costs. You may also need to pay an attorney.
- You may have a longer loan term. If you consolidate one or more loans, then you may end up with a longer term than you had on your previous loans.
- You may have a higher rate. Depending on your credit score and overall financial circumstances, you may not be able to qualify for an advantageous interest rate.
- You may lose benefits on previous loans. An example would be if you had an income-driven repayment plan (IDR) for a federal student loan, you might lose credit for any payments you made toward loan forgiveness.
Debt consolidation doesn’t solve underlying financial issues. If you’re someone who has struggled with overspending, you should be aware that debt consolidation won’t solve that issue and might even worsen it.
It’s important to recognize what debt consolidation can and can’t do for you before you begin the process.
Does Debt Consolidation Affect Your Credit?
Before we review how to consolidate debt without hurting your credit, let’s talk about the impact that debt consolidation can have on your credit score.
If you are a Leaders member, you can track and monitor your credit score online or in your mobile app.
There are several ways that applying for and carrying out debt consolidation can change your credit score. Some of the impact will be positive, while there are a few things that could be negative. That said, you’ll be able to minimize the negative impact of your actions after debt consolidation.
Let’s start with the positive impacts. You won’t see these effects immediately, but over time, you’ll see your score improve as you make on-time monthly payments. These payments will reduce your credit utilization score, especially if you leave your paid-off credit cards open. (As a rule, you want your utilization percentage to be 30% or lower. Leaving your other cards open increases your available credit, which in turn decreases your utilization. You can leave them open even if you no longer have a credit card balance.)
It’s important to note that if you’re consolidating loans, leaving those open is not an option after you’ve consolidated your debt. You’re unlikely to see a positive impact from that, but the effect should be neutral because your debt amount should stay close to where it was, at least at first.
If you’ve been struggling to make your monthly payments on time, making on-time payments will also improve your payment history, which accounts for 35% of your credit score.
One small negative impact you can expect to see will occur upfront when your lender or credit card company does a “hard” credit check to approve you for debt consolidation. Typically, the result will be a small drop in your credit score, usually no more than five points. Your credit score should rebound within a few months at most.
We should note here that there’s no need to worry about multiple credit checks having a cumulative impact on your credit score. If you approach multiple lenders about a debt consolidation loan, all inquiries within 30 days are treated as a single inquiry for the purposes of your credit score. You’ll be able to monitor your credit report to see the impact.
The good news for anybody with bad credit is that making timely payments will have an ongoing positive impact on your credit score.
5 Best Ways to Consolidate Debt Without Hurting Credit
Now, let’s run through the best ways to consolidate debt without hurting your credit. Here are five debt consolidation strategies to consider.
#1: Transfer Your Debt to a Balance Transfer Card
The first option is to take your existing high-interest debt and transfer it to a balance transfer card. Your credit score will take a small initial hit when the credit card company does a hard credit pull to confirm your eligibility.
As we noted above, it’s essential to keep your old credit cards open even after they’re paid off. This strategy means that your available credit will be higher than it was before and that will reduce your credit utilization percentage. Since credit utilization accounts for 30% of your credit score, you should see an improvement in your credit soon after consolidating your debt.
#2: Take Out a Personal Loan
Personal loans may also be used for debt consolidation. In this case, you would take out the loan and use the proceeds to pay off high-interest debt. Keep in mind that you’ll need to pay closing costs.
With a debt consolidation loan, the same rules apply as for a balance transfer credit card. You’ll take a small initial hit to your credit score. Leaving credit cards open may improve your credit score. However, you won’t be able to keep loans open after they are paid off, so you should keep that in mind.
#3: Borrow Against Your Home Equity
There are several ways you can borrow money against the equity you’ve accrued in your home. These include the following:
- Home equity loan
- Home equity line of credit
- Cash-out refinancing
In each case, your lender will use the equity you’ve accrued in your home as collateral. If your credit is solid, you should have no problem qualifying. Just as you would with a personal loan, you’ll need to pay closing costs.
#4: Transfer Balances On Your Own
There’s one debt consolidation strategy to avoid taking a hit on your credit score. The strategy is that if you already have a credit card with a low- interest rate, you can use it to pay off your other cards, thus reducing your debt to one payment per month.
The downside with this option is that you won’t be able to take advantage of a low introductory rate as you would with a balance transfer card. That said, you could reduce your monthly payment thanks to the lower interest rate and improve your credit score by leaving your other cards open.
#5: Forget Consolidation and Create a Debt Repayment Plan
The final option is to forget about debt consolidation and create a debt repayment plan that works for you. Here are a few strategies to consider:
- The avalanche method requires you to make extra payments each month on the debt with the highest interest rate. Once you pay that off, you roll your extra payments into the next highest interest rate and so on.
- The snowball method involves making extra payments on the debt with the lowest balance. Once that’s paid, you move to the next highest balance.
- The snowflake method involves making extra payments to all of your creditors every month.
Any one of these methods can work, but you’ll need to create a monthly budget and stick to it. It’s important to avoid overspending if you want to get out of debt.
Consolidate Your Debt with Leaders Credit Union
Debt consolidation can be a good debt management tool if you feel overwhelmed by multiple monthly payments and you’re determined to get out of debt. Any one of the five methods we’ve covered here can work based on your preferences and financial situation.
Do you think debt consolidation is the right solution for you? Leaders Credit Union is here to help! Learn more about our low-rate personal loans here and download our free smart budgeting toolkit to get your finances on track today!
