You may have heard a lot of promises from companies offering to consolidate your credit card balances. While they offer rock-bottom interest rates and slashed payback balances, in reality you may not qualify for those rates and the consequences of taking on consolidation may not be worth the initial advantages. Make an educated decision about whether to consolidate so that you are fully committed to your plan to get out of debt.
Consolidation Loans
You may consolidate your credit card debt using a consolidation loan, which is a loan taken out against collateral, such as your house. A consolidation loan pays off your credit card balances, bringing them to zero; instead of making multiple payments to your credit cards each month, you make one lump payment to your loan. Often, consolidation loans are advertised at very low rates, but these are usually for those with extremely high credit. Many people also fall prey to using their newly freed credit, continuing the cycle of debt. According to Bank Rate, 70 percent of people who take on a consolidation loan end up with the same or more debt within two years.
Debt Management Plans
Considered the last step before bankruptcy, debt management plans (DMPs) may only be taken on when recommended by a credit counselor. Under a DMP, your credit counselor will contact your creditors to attempt to negotiate lower interest rates and/or balances for you to pay back. The counselor then comes up with a time frame for you to pay off your debts. Usually, those on debt management plans are prohibited from applying for new credit. A debt management plan stays on your credit report for up to seven years.
Balance Transfers
If a card offers very low interest rates, it may be beneficial to transfer your balances; however, you must be careful not to damage your credit further by using balance transfers inappropriately. Opening a new account alone docks five points from your credit score. Also, your debt-to-credit ratio is one of the main factors in determining your credit score; if your new card has a low credit limit, transfers may cause your credit score to drop further, since the credit bureaus don't differentiate between a large purchase and a balance transfer.
Considerations
Simply having a consolidation loan or a debt management plan doesn't cause your score to fall. What determines the effect on your score is the way you manage the consolidation process. However, consolidation loans and debt management plans are seen as blemishes on your credit report. They show borrowers that you've had difficulty making payments in the past, which may make them hesitant to lend to you. DMPs, in particular, cause lenders' hesitation, since you generally don't pay the full amount owed. If you can manage to lower your credit card interest rates, you may get a better deal than through a consolidation loan without the negative impact on your credit report.
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