When it comes to credit cards, your best bet is always to pay your balance in full every month. Unfortunately, that’s not always possible. Sometimes life happens and people make mistakes when it comes to managing their credit card accounts. Other times people use credit cards in such a way that they simply don’t have enough disposable income to pay them in full.
Either way, if you’ve charged more on your credit card accounts than you can afford to simply pay off, debt consolidation is one option that might help you to eliminate your high-interest debt. While considering whether debt consolidation will save you money, it’s also important to consider how consolidating credit card debt impacts your credit scores.
The news is generally good. Consolidating credit card debt not only has the potential to save you money on interest charges, but it might also give your credit scores a boost at the same time. Of course, it all depends on which method you choose to consolidate your debt, and how well you manage that process.
How Credit Card Debt Impacts Your Credit Scores
Before you can understand how credit card consolidation might help your credit scores, it’s helpful to understand how credit card debt affects those numbers in the first place. As far as credit scores are concerned, high credit card utilization isn’t a good thing. In fact, it’s just the opposite.
Credit scoring models, like FICO and VantageScore, are designed to pay close attention to the relationship between your credit card limits and your balances. This is known as your revolving utilization ratio. As you use more and more of your credit limit, your revolving utilization ratio increases. This almost always lowers your credit scores.
- Read more: How Credit Scoring Models Actually Work
Best Ways to Consolidate Credit Card Debt
Consolidating your debt is a process where you take multiple outstanding account balances and combine them together. With credit cards specifically, there are multiple ways you can consolidate your debt. Here are two popular options:
- Balance transfer: A balance transfer involves using another credit card account (new or existing) to pay off the balances on your other credit cards. You move the balances from your high-interest cards to a lower-interest card — sometimes even with a 0% APR introductory period.
- Personal loan: A personal loan or an unsecured installment loan can be used to pay off the balances on your revolving credit card accounts. In this case, you’re borrowing money in the form of a single loan for the purpose of paying off your various credit card debts, and you’ll repay the single loan.
When Consolidating Helps Your Credit Scores
If you manage the process wisely, there’s a good chance that consolidating credit card debt could improve your credit scores.
Remember, a high utilization rate on your credit cards can potentially drive your scores downward. When you use a personal loan to pay off all of your credit card balances, your revolving utilization drops to 0%, because you’re paying off your revolving debt with an installment loan. And while you have the same amount of debt, the new debt is no longer considered credit card debt.
Of course, if you consolidate your credit cards onto a new balance transfer card, your revolving utilization ratio won’t be reduced by as much. A balance transfer card with a low introductory rate could potentially save you more money in interest charges if you can pay off the debt before the teaser rate expires, but the positive impact on your scores might not be as noticeable.
You shouldn’t decide to consolidate your credit card debt without taking a moment to at least consider the potential downsides. Although consolidation will often save you money and could help your credit scores, too, there’s a chance the process could backfire if it’s not managed well.
Sometimes people consolidate their credit cards but, with the illusion of a clean slate, get into even more debt in the end. If you pay off your existing credit card balances with a new loan or balance transfer, you have to put those old spending habits on hiatus.
If you continue to use the existing credit cards and spend more than you can afford to pay off in a given month, you’re likely going to end up in twice as much debt.
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John Ulzheimer is an expert on credit reporting, credit scoring, and identity theft. The author of four books on the subject, Ulzheimer has been featured thousands of times over the past decade in media outlets including the Wall Street Journal, NBC Nightly News, The Los Angeles Times, CNBC, and countless others. With professional experience at both Equifax and FICO, Ulzheimer is the only credit expert who actually comes from the credit industry. He has been an expert witness in over 230 credit related lawsuits and has been qualified to testify in both federal and state courts on the topic of consumer credit.