Will Debt Consolidation Help or Hurt Your Credit?

Debt isn't always a bad thing. In fact, it can help your small business thrive.

From student loans to a house mortgage, debt accumulation is stressful and overwhelming. As you make moves to get out of debt, you might want to consider consolidating credit cards or other loans to save you time and money. But that begs the question—does debt consolidation help or hurt your credit?

The answer depends on how you consolidat­e and what you do with your debt afterward.

1. Debt Consolidation Loans

Getting a new loan to pay off other debts is the most popular way to consolidate. It’s certainly what most people think of when they consider consolidation. But finding a loan that has decent terms and is designed specifically for the purpose of consolidation can be challenging—especially if your credit scores are a bit lower due to the balances you’re carrying.

It’s certainly not impossible, though. Look for reputable debt consolidation companies that will work for your specific situation.

Tip: Triple check lenders’ certifications to make sure you’re dealing with a legitimate site if you’re shopping for a loan online. Scams abound.

Effect on Your Credit: Consolidating credit cards with high balances using an installment loan (i.e. a loan with fixed monthly payments) may actually benefit your credit rating, especially if you use the loan to pay off credit cards that are near their limits. At the same time, any new loan can cause a short-term dip in your credit scores—so don’t be too surprised if you see your credit score change slightly when taking out a new loan.

2. Debt Management Plans

Debt management plans are often confused with debt consolidation—however, they’re very different programs. Debt management plans (DMPs) are offered through credit counseling agencies and, much to many people’s surprise, they don’t actually consolidate your debt.

Instead, you make a “consolidated” payment to the counseling agency, which then pays each of your creditors—usually at a reduced interest rate. Even though you’re making only one or two monthly payments, the counseling agency doesn’t actually pay off your creditors for you—it simply acts as a middle man to help you repay your debts and ensure that the creditors get the money they’re owed. These programs are available regardless of credit scores, so if you are having trouble consolidating, a DMP might be worth considering.

Tip: If you choose to move forward with a DMP, you should close or suspend your credit card accounts. Unfortunately, you’re not permitted to use credit cards while enrolled in a DMP.

Effect on Your Credit: If you have a good credit score and adhered to a creditor’s repayment terms in the past, a DMP could have a negative impact on your credit as it indicates that you are experiencing or have experienced difficulty with payments. Also, since a DMP directly impacts payment terms, credit reporting agencies might ping your DMP commitment because it designates a change in payment policies.

3. The Credit Card Shuffle

Transferring a high-rate credit card balance to a card with a lower rate is another way to consolidate. Carrie Rocha, author of Pocket Your Dollars: 5 Attitude Changes That Will Help You Pay Down Debt, and her husband paid off some $60,000 in debt, and taking advantage of low-rate balance transfers was one of the strategies they used to dig out. However, if you decide to go this route, you must be very disciplined in your approach. Otherwise, you may fall into traps such as getting stuck with a balance at a high interest rate after the introductory period ends.

Tip: Read the fine print. Keep your eyes peeled for any “but” or “until.”

Effect on Your Credit: It depends on how you use a transfer. You’ll often see a temporary dip in your credit score when opening any new card. If you use a substantial portion of the available credit (on the card) to consolidate balances from other cards with lower balance-to-available-credit ratios, your credit scores may drop from that as well. Finally, you may also lose points if you open a new card and use a majority of the credit line to consolidate.

However, if a 0% card allows you to save money and pay off your debt faster, you can come out ahead in the long run, both financially and credit score–wise.

The End Goal: Less Debt Equals Stronger Credit

Paying down debt can have a tremendous impact on your credit scores. According to FICO, the company behind most of the credit scores used by lenders, consumers with high credit scores (e.g. 785 and above), tend to keep their balances low. Specifically, two-thirds of consumers with good credit carry less than $8,500 in non-mortgage debt, and they use an average of 7% of their available credit on their credit cards.

That means that paying off debt—whether you use a consolidation loan or just put every penny you can toward your debt—will often improve your credit ratings in the long run. The biggest risk, though, is that it’s easy to run up new balances on the cards you paid off in the consolidation—and that’s definitely not a good move for your credit or your bottom line. As you make progress on paying off your loans, periodically check your free credit report to see where you stand.

Remember, moving debt is a means to your end. The goal is to pay off those balances and free up cash flow as well as to help build strong credit. So whether it’s a consolidation loan, credit card shuffle, or DMP, know your options so you get there just a little faster.

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Consolidating Your Debt? Consider These 6 Downsides First

Your next debt collector may never say a harassing thing to you at all. That debt collector might also not be human.

Credit card debt among Americans is at an all-time high.

In June, it increased to $1.02 trillion, according to a report from the Federal Reserve. In other words, Americans now have more credit card debt than just before the 2008 financial crisis.

When facing such massive amounts of debt, it may be tempting to consider consolidation, one of the most popular ways for consumers to cope with mountains of bills. But before making such a move, it’s important to think about the potential downsides and drawbacks—and there are quite a few.

“Debt consolidation is rarely a good option,” says Holly Morphew, a certified financial health counselor. “Those looking to consolidate debt usually don’t understand what it is and are simply stressed about unmanageable debt and looking for a way out of it.”

Among the nuances to understand is how consolidation impacts your credit score, what your new interest rate will be, and what the repayment terms are—particularly when consolidating student loan debt, which can be dangerous, says Morphew.

Here are six of the biggest drawbacks to keep in mind when considering debt consolidation.

1. Transfer Fees

Consolidating credit card debt via a balance transfer to a new card can seem enticing, especially when there are so many 0% APR offers being presented to you at every turn. But Han Chang, cofounder of InvestmentZen.com, warns that nothing is ever free.

“Offers like this usually come with a one-time balance transfer fee ranging from 3% to 10% of the total balance transfer,” says Chang. “That can really add up and, if you’re not careful, completely negate any savings that 0% APR offers.”

2. Government-Backed Program Losses

Another often-overlooked drawback of debt consolidation is the potential loss of government-backed programs, primarily pertaining to student loans. While there can definitely be some advantages to combining all of your student loans, be sure to read the fine print of your new agreement carefully.

In particular, determine whether you’ll still be eligible for common federal government perks.

Morphew says student debt consolidation is actually one of the most risky things to do.

“If you don’t choose the right company, or decide to consolidate federal subsidized loans into a private loan, you can lose those repayment benefits such as deferment, forbearance, and loan forgiveness,” she says.

3. Credit Score Dings

If you are working with a debt consolidation company or a financial institution to combine your bills, the company will likely conduct a hard credit inquiry. While the effects of this inquiry are temporary, says Chang, be prepared to see your credit score drop in the short term.

“If multiple creditors pull reports, your score could drop significantly,” he adds. You can keep an eye on your credit score by reviewing your credit report for free on Credit.com.

4. Unchanged or Increased Interest Rates

Often the goal of debt consolidation is to secure a lower overall interest rate. But that’s not always what happens, says Morphew. You can actually end up paying more because the company giving you the new consolidated loan will average the rates on your debt and round up based on its terms, she says.

In addition, if you have poor credit to begin with, you may not qualify for a lower interest rate, says Amber Westover of BestCompany.com.

“You may end up paying more for your debt over the course of your consolidation loan,” Westover says.

5. Expensive Debt Consolidation Costs

Debt consolidation companies don’t work for free. Many national companies offering this type of service charge a fee of 15% of the total debt, says Richard Symmes, a consumer bankruptcy attorney.

“This leads the consumer to pay much more than if they had negotiated with the creditor on their own. Many of these fees may even be fraudulent under individual state laws, which cap how much a company can charge for debt consolidation services,” he says. He instead suggests conducting such negotiations with the help of an attorney, who simply charges a flat fee.

6. Increased Overall Loan Costs

One last drawback worth noting: just because your monthly payments may go down under a debt consolidation program doesn’t necessarily mean your overall debt is going down.

“If you consolidate high-interest short-term debt for very long-term debt, then you may actually be paying more,” says financial analyst Jeff White. “For instance, paying $500 per month for one year (which translates into $6,000) is less than paying $75 per month for 10 years (which is $9,000).”

Consolidating could be a smart financial move, or it may just sound like it. To find out if consolidation or another debt management strategy is right for you, visit our Managing Debt Learning Center.

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Goldman Sachs Is Offering Debt Consolidation Loans: What You Need to Know

Goldman-Sachs

There’s a new credit card debt consolidator in town — but its name is likely familiar to you.

Investment banking giant Goldman Sachs announced on Thursday that it will begin offering unsecured personal loans to people looking to pay off high-interest credit card debts. The loans will be offered through a new online platform, Marcus: By Goldman Sachs, named after Marcus Goldman, one of the firm’s founders.

Borrowers can apply for fixed-rate, no-fee personal loans of up to $30,000 for periods of two to six years, the firm said in a press release. According to Marcus’ website, applicants will be offered annual percentage rates (APRs) ranging from 5.99% to 22.99%. Late payments, partial payments, missed payments or defaults on the loan can show up on your credit report.

The platform isn’t fully open to the public just yet: Initially, applications will require a code that millions of prospective customers will receive by mail. You can request one on Marcus’ website.

“The feedback we expect to hear from the initial group of customers will help us to refine the Marcus experience,” the firm said in the release. It plans to offer the personal loans to a broader audience in coming months.

Debt Consolidation 101

Goldman — or, maybe we should say, Marcus — isn’t the only one who wants to pay off your plastic. Consolidating high-interest credit card debt with a personal loan has long served as a way for people to potentially cut down the lifetime costs of their existing debts and provide themselves with a hard date for when they can be out of the red.

But there are risks involved with this strategy: For instance, undisciplined spenders could find themselves worse off if they take out a personal loan, pay their credit card balances down and run them right up again. And when converting your revolving credit card debt to an installment loan, you’re locking yourself into a fixed monthly payment you will have to make (otherwise, your credit score could take a hit), which could be problematic if you hit financial setbacks down the line.

Plus, generally, only good credit scores qualify for a lender’s best terms and conditions, so if your credit isn’t exactly stellar — a strong possibility for folks carrying large amounts of debt — you may not be an offered an APR lower than the one you’re already paying. In any event, it’s a good idea to shop around and read the fine print of any offer you receive to be sure it’s right for you. You can learn more about the pros and cons of debt consolidation loans here.

If you decide to shop around, it can help to brush up your credit score ahead of time. (You can view two of your scores, updated every 14 days, for free on Credit.com.) If your score is currently looking shoddy, you can potentially fix it by paying down high credit card balances (we get it, that’s sometimes easier said than done), disputing errors on your credit reports and limiting new credit inquiries while your score rebounds.

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Should I Take Out a Loan to Pay Off My Credit Cards?

man_cut_credit_card

Anyone who has ever had credit card debt knows these two things: It’s expensive, and it can take forever to pay off.

You can save a lot of time and money by increasing the amount of money you pay toward the debt every month — using a credit card payoff calculator like this one helps you figure that out — but that’s not the only way to reduce the cost of getting out of credit card debt. You could also use a personal loan to consolidate your balances.

Personal loans often have lower interest rates than credit cards. Credit cards also tend to have variable interest rates, which can make paying off the balances a little less predictable than personal loans, which generally have a fixed rate. On top of that, people sometimes struggle to pay off debt while continuing to use their credit cards. Because personal loans are installment loans — you can’t add transactions to them like you can a credit card — it can be easier to work toward that end goal of getting out of debt.

Personal loans can also be extremely helpful for people whose credit card debt involves multiple cards. By paying off all your credit card debt with the personal loan, you make the debt easier to manage with a single payment and a single interest rate.

Keep in mind you have to apply for a personal loan, which will result in a hard inquiry on your credit report and a slight ding in your credit scores, and the better your credit score is, the better your interest rate on your personal loan will likely be. Interest rates and loan approval also depends on how much much you’re asking to borrow and your ability to repay the loan (like your income or other debt obligations you have).

Before you apply for a loan to consolidate your credit card debt, get an idea of where your credit stands: You can get a free credit report summary, updated every 30 days, on Credit.com. That summary will show you an aspect of your credit scores called “account mix” and if you happen to have no open installment loans, a debt consolidation loan could actually help you in that area.

Personal loans aren’t the only strategy for paying off credit card debt. You might also want to consider a balance transfer (here’s an expert guide to picking a balance transfer credit card), which can give you some breathing room from your debt during a promotional period of 0% interest. Again, you’ll want to check your credit and consider the balance transfer fees involved before applying.

More on Credit Cards:

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