Credit Advice » Debt » Managing Debt » I’m Thinking About Consolidating My Debt. Is That a Good Idea?

I’m Thinking About Consolidating My Debt. Is That a Good Idea?

Dear Experian,

Is it a good idea to obtain a personal loan to consolidate or pay off credit card debt? I currently pay approximately $800 a month to credit card debt. The loan I was looking into would be $400 a month.

– JFY

Dear JFY,

People often ask us about debt consolidation and whether consolidating their debts will affect their credit. Whether consolidating your debt is a good idea depends on both your personal financial situation and on the type of debt consolidation being considered. Consolidating debt with a loan could reduce your monthly payments and provide near term relief, but a lengthier term could mean paying more in total interest.

Consolidating Debt with a Personal Loan

When people mention debt consolidation, they are usually referring to one of two different methods. The first is the kind you describe, where you apply for a personal loan, preferably one with a relatively low interest rate, and then use the money from that loan to pay off all your credit card balances at once.

Once all of your other accounts are paid in full, there is only one payment to make every month – the one to the new lender. Since the interest rate on a personal loan is often considerably lower than on a credit card, and the repayment term potentially much longer, the consolidated payment may be much lower, as you indicated.

If you are struggling to keep up with your monthly payments, consolidating your debt in this way can certainly help alleviate financial stress. It can also make it less likely that you will fall behind on your payments and risk harming your credit. For these reasons, taking out a personal loan to consolidate higher interest debt can often be very beneficial.

Keep in mind that even though the interest rate may be lower with a personal loan, you could end up paying more in interest over time because the repayment terms are longer. Once you are in a position to do so, an option to reduce that cost is to use the money you will be saving to pay extra on your loan each month and pay the loan off sooner, thereby saving some money on interest over the course of the loan.

Consolidating Your Payments with a Debt Settlement Company

The second type of debt consolidation you may hear about are debt management plans offered by debt settlement companies. With these programs, the debt settlement company may be able to secure lower monthly payments with your creditors by negotiating a reduced balance on your accounts. You then make one “consolidated” payment to the debt settlement company each month, and in turn the company makes payments to each of your creditors on your behalf.

Once an account is included in this type of program, the creditor will close the account. Closing your credit cards will cause your credit utilization rate to increase, which can hurt credit scores. The creditor may also add a statement to the account that indicates the payments are being managed by a debt consolidation company. This statement may be viewed negatively by lenders who manually review your report.

Programs like this may lower your monthly bills, but because you are not re-paying the full amount owed on your accounts, your creditors will likely report those accounts as “settled” or “settled in full for less than the full balance.” Because it indicates that you did not pay the account as agreed, a status of settled on your credit report will impact your credit scores negatively, even if there are no late payments on the account.

Even though the debt consolidation company will be making payments on your behalf, you will still be responsible for ensuring those payments are made to your creditors on time. If the debt consolidation company fails to make a payment on time, the late payment will be reflected on your credit report. Even one late payment will have a negative impact on your credit scores.

Before entering into any debt consolidation plan, research the offer to make sure that the company is reputable and that you fully understand the terms and implications of the program.

Thank you for asking,
The “Ask Experian” Team

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