Credit card debt can be both a financial burden and a roadblock to achieving your long-term financial goals, including buying a home or saving for retirement. Debt consolidation can be helpful because it allows you to make a single monthly payment, often at a lower interest rate than what you would pay if you left your debts where they are.
Our Addition Financial members often ask us about debt relief and the impact credit card consolidation will have on their credit. The answer may surprise you. Here’s what you need to know about how to consolidate credit card debt without hurting your credit.
How much credit card debt is normal?
Let’s start with the topic of credit card debt and how much is normal—and how much is too much. According to Forbes, Americans hold a total of $925 billion of credit card debt as of November of 2022, an increase of 15% from 2021. The average debt is $6,004, which means that many Americans owe more than that amount to credit card companies.
The issue of how much credit card debt is too much is highly individual and depends upon factors that include your available credit, how much credit you’re using and your net monthly income.
One of the easiest ways to determine whether you have too much credit card debt is to calculate your credit card debt ratio. You can do that by dividing your total credit card payments by your net monthly income. Most experts recommend a credit card debt ratio of 10% or less. You should keep in mind that even if your ratio is below 10%, you may have too much debt for your circumstances if you find yourself scrambling to scrape together enough money to make the minimum payments each month.
How does debt consolidation affect your credit score?
There are two main options if you want to consolidate your credit card debt, as follows.
Balance transfer credit card
A balance transfer credit card is a credit card that offers a low introductory rate to people who want to consolidate their debt. After approval, the card holder provides information about balances to be transferred. The balance transfer card issuer typically (but not always) charges a balance transfer fee of between 3% and 5% of the amount being transferred. After the balances are transferred, the card holder makes a single monthly payment which is often lower than the total of the monthly payments before consolidation.
Debt consolidation loan
A debt consolidation loan is a personal loan where the borrowed amount is used to pay off credit card debts. Since the interest rates for personal loans are usually lower than the average credit card interest rate, the result is a lower and more affordable monthly payment. As is the case with any loan, the borrower is responsible for closing costs that should total between 2% and 5% of the loan amount.
Debt consolidation and your credit score
Whether you choose a balance transfer credit card or a debt consolidation loan, the card issuer or the lender will pull your credit report to determine your creditworthiness. A so-called hard credit inquiry, which would be required for debt consolidation, will have a temporary and minor negative impact on your credit score.
It’s important to note that for most people, assuming that there is an effort to budget responsibly and avoid overspending, debt consolidation will improve your credit score in the long run. If you make regular on-time payments and avoid adding to your debt, your credit score may improve substantially.
How much debt do you need to consolidate?
Another question we hear frequently has to do with the requirements for debt consolidation. Specifically, people want to know if there’s a minimum amount of debt to qualify for debt consolidation.
The answer is no, although individual lenders may have minimum loan amounts for personal loans. For example, the minimum for our Signature Loan, which is often used for debt consolidation, is $500. The maximum amount is $30,000.
You should keep in mind that you’re under no obligation to consolidate all of your credit card debts if you decide consolidation is right for you. For example, if you have one credit card with a low credit rate that’s locked in, you may want to leave that existing debt where it is and consolidate those balances with higher interest rates.
The most important thing to remember about credit card debt consolidation is that the goal is to eliminate or reduce stress while lowering your monthly payment. That means that you should look for either a balance transfer credit card or a personal loan with an interest rate that’s lower than what you’re currently paying.
What are the benefits of consolidating debt?
There are some advantages to consolidating your debt:
- Lower monthly payment. In most cases, debt consolidation translates to a more affordable monthly payment due to a reduction in your interest rate.
- Streamlined finances. It can be stressful to keep track of and make multiple monthly credit card payments, and consolidation allows you to make a single payment.
- Expedited payoff. A lower monthly payment may mean that you can afford to pay a little extra and get you out of debt faster than would be possible without consolidation.
- Improved credit score. While the initial hard inquiry required to consolidate your credit card debt will cause a dip in your credit score, reducing your credit utilization ratio and making timely debt payments will help you improve your credit score over time.
These advantages make it clear why many people want to consolidate their debt.
What are the downsides of consolidating debt?
Here are some of the potential disadvantages of consolidating your credit card debt:
- Added costs. In most cases, debt consolidation comes with a price tag. Balance transfer credit cards usually charge a transfer fee (Addition Financial’s balance transfer card has no transfer fee) and lenders always charge closing costs for a loan. You’ll need to factor the expense into your decision.
- More long-term debt. While you may lower your monthly payment with debt consolidation, it’s important to keep your long-term costs in mind. You should calculate your total costs to determine if credit card debt consolidation is right for you, including your closing costs or transfer fees.
- Changing interest rates. A credit card balance transfer usually comes with an attractive introductory interest rate, sometimes as low as 0%. However, these rates always have an expiration date. You’ll need to read the fine print and crunch the numbers to make sure you understand how much you’ll pay if you don’t eliminate your debt before the introductory period ends.
- Underlying issues. While debt consolidation can be useful, it’s not going to eliminate any underlying bad financial habits that caused you to get into debt in the first place. If you do consolidate debt, make sure to create a budget and commit to responsible spending to avoid the risk of accumulating additional debt.
We suggest reading the fine print on any debt consolidation offer you’re considering, crunching the numbers to determine your total cost and creating a realistic monthly budget and debt management plan to help you pursue your financial goals.
What’s the best way to pay off credit card debt without hurting your credit?
The answer to how to consolidate credit card debt without hurting your credit depends on a variety of factors, including the amount of credit card debt you have, your credit history and your income. Let’s look at a couple of potential scenarios to illustrate the point.
Our first scenario involves someone with $20,000 of credit card debt, high by most standards, and a solid credit score of 700. Because this person has a good credit score, they are likely to be able to qualify for either of the debt consolidation methods we have discussed.
With a debt consolidation loan, the benefit would be an advantageous interest rate and predictable monthly payments, either of which could help this person pay down their debt. If they had enough income to make extra payments on the loan, our suggestion would be to look for a loan with no prepayment penalty and to create a budget that would allow for additional payments to accelerate the process of getting out of debt.
Because the amount to be repaid is high, a loan is likely to be a better option than a balance transfer card unless there was a realistic possibility of paying off the debt before the end of the introductory low interest rate. This person would take an initial hit to their credit score but would likely improve their score quickly by paying extra each month.
Scenario #2 involves someone with a low credit score and less credit card debt. These two facts may make it difficult for them to qualify for either a balance transfer card or for a debt consolidation loan.
In this case, the best way for this person to consolidate their debt would be to shop around for a debt consolidation loan to see if they could get a lower interest rate. They might not be able to qualify for a balance transfer credit card, but a lower amount owed might make that option attractive if they could budget to pay off their debt during the introductory period. They might be able to boost their credit score by paying a little extra on their debts for a few months before applying for a credit card.
Consolidate your debt With Addition Financial
The best way to consolidate your credit card debt without hurting your credit is to shop around for the most advantageous interest rates. The solution may be a debt consolidation loan or a balance transfer credit card, and in either case, you should crunch the numbers to make sure that you’ll save money in the long run.
Do you need an affordable way to consolidate your debt? Addition Financial can help! Click here to read about our Platinum Low Rate credit card and apply today.