The Best Way to Consolidate Debt Without Hurting Your Credit
If you are considering a personal loan for debt consolidation, you may be worrying that this will damage the very thing you are trying to protect: your credit. Let’s look at the best way to consolidate debt without hurting your credit.
Will Consolidating My Debt Hurt My Credit Score?
While juggling card balances and incurring late fees is no fun, taking charge of your debt also involves opening new accounts or taking out new loans. If you’re wondering how to consolidate credit card debt without hurting your credit, read on.
We’ll consider options for managing high-interest borrowings and look at how to consolidate debt into one payment by taking out a personal loan. But first, let’s start with the basics.
How Does Debt Consolidation Work?
When you consolidate your debts you effectively transfer money that you owe to several creditors into one loan. To do this, you borrow money or access credit from a single source and use it to pay off some or all of your other outstanding debts.
Debt consolidation works when you replace several high-interest or short-term debts with a single debt payable over a longer term or at a lower interest rate or annual percentage rate (APR) and work to pay this debt off over time. You’ll save money by avoiding more late fees and other penalties, and by reducing what you would have been paid in future interest rate charges.
In order to build financial stability and eventually begin to save your own money, however, you also need to be sure to control your spending and not incur fresh debts.
How Does Debt Consolidation Affect Your Credit?
Debt consolidation will temporarily lower your credit score because you’re accessing additional credit. Any lender will make a “hard inquiry” on your credit when you apply formally for a loan, and this typically results in a drop of about 10 points in your credit score. A hard inquiry remains on your credit record for one year.
This small short-term drop in your credit score needs to be seen in the context of what you’re trying to achieve by consolidating your debt. Moving what you owe into a single, predictable long-term payment usually at a lower annual percentage rate reduces your overall debt-to-income ratio and your debt-to-credit ratio.
Improving these two factors over time will have a far greater positive income on your credit score than the short-term knock it will take from the actual consolidation. Plus, better credit will unlock more financial opportunities for you in the future.
What’s the Best Way to Consolidate My Debts?
Both balance transfer cards and personal loans are common ways to consolidate debt and can offer different advantages depending on your situation.
Balance Transfer Cards
Balance transfer credit cards are credit cards that allow you to transfer balances on one or more other cards for little or no cost, usually during a special introductory window—just like what we offer with our VISA® Cash Back card.
Many cards also charge zero interest during the six-month introductory period, which can provide a valuable chance to clear some of the debt or at least get ahead on payments.
Balance transfer cards can be a good way to reduce the number of outstanding balances you have and get control of smaller outstanding debts. However, you’ll likely be charged a high-interest rate on a larger balance once the introductory grace period ends, and your APR can increase if market rates rise.
You will also likely be strongly tempted to continue to use your card for purchases, which will add to your debt as you’re trying to pay it off. And, your credit report will record it as just another credit card or source of high-interest debt, especially if you continue to rack your balances.
A personal loan from a reputable credit union or bank is the most popular way to consolidate significant debt—and for good reason. Typically, a personal loan:
- Is not secured by collateral in the form of cash or a lien on your house or car
- Has a lower interest rate than credit cards, unpaid bills, and other common forms of debt
- Has flexible repayment terms, from a few months to several years, to meet your needs
- Has a fixed-interest rate, so you know exactly what you will pay over the life of the loan
Personal loans are also pretty straightforward to apply for, and while your credit score will take a small short-term dip, the long-term benefits of gaining control of your debt will outweigh this and will be reflected on your credit record soon.
These consolidation options allow you to replace two or more higher-interest debts, each with its own due date, fees, and penalties with a single, predictable payment for the same amount every month.
When Is Consolidating Your Debt a Good Idea?
Debt consolidation is a good idea if you own significant amounts on multiple accounts that you cannot cover with your monthly budget. If your credit card balances are growing larger each month or you are juggling payments due and incurring late fees, then debt consolidation may offer you a good solution.
Consolidating your debt alone, however, will not make it go away unless you change your spending habits. Your consolidated debt may be more manageable, but you’ll only be able to pay it down if you stop overspending and avoid accruing fresh debts.
Taking out a personal loan is a sensible choice if you have significant debts that you would struggle to pay in more than a month or two of careful budgeting. While seeing everything you owe in one place might be intimidating at first, paying down a consolidated loan, sticking to a budget, and avoiding further borrowing is a proven path out of long-term debt.
If you have outstanding debts that would make it difficult to qualify for a loan, you are struggling to make payments on what you already owe, or if you recognize that you would be unable to stick to a budget or stop borrowing further, then you should contact your creditors immediately to negotiate a payment plan.
Financial Counseling and Education
Becoming better educated about finances is another way to take control of your financial future. To that end, Freedom Credit Union has partnered with GreenPath, a national financial counseling nonprofit organization, so that our members can receive expert advice on everything from low credit scores to debt consolidation.
Through this partnership, our members can take advantage of free financial counseling, plus have access to podcasts, programs, and webinars. GreenPath’s guidance, information, and tools provide a tremendous resource that not only helps our members achieve their financial goals—but also improves their financial well-being.
Freedom to Choose Your Financial Future
If you’re seeking a personal loan to consolidate existing debt, consider talking to your credit union.
Credit unions have strong ties to your neighborhood and will take the time to get to know you and understand your needs in a way that few commercial banks still do. Step into Freedom Credit Union and you’ll also work directly with the people approving your loan.
At Freedom Credit Union, we’ve been serving greater Philadelphia for decades. As a member, your success is our success. Talk to us about securing your financial freedom by consolidating your high-interest debt into a personal loan. We offer:
- Great interest rates
- No monthly or prepayment fees
- Free FICO® credit score checks
- A fixed APR with no surprises, so you can plan for a better future
Talk to us about a loan that meets your needs today while helping you build for tomorrow —because for us, it’s personal.