A revelation that likely won’t shock you — credit cards often have very high interest rates. A report from the CFPB estimates standard credit cards can cost consumers around 14% annually (mostly in fees), while private label credit cards can cost consumers as much as 21%.
If you can relate, are tired of paying a small fortune in interest and need a way to figure out how to pay off debt, you may be considering consolidation. Consolidation involves taking out a new loan and using the proceeds from that new loan to pay off multiple existing debts owed on your credit cards.
Not only could it dramatically reduce your interest rate, but it can also make life more convenient since you'll have just one lender to pay instead of many different credit card issuers.
Common Consolidation Loan Options
- Balance Transfer Cards. You could use a balance transfer card to consolidate debt. This means using a credit card — ideally one with a 0% balance transfer APR for a set number of billing cycles — to pay off existing credit card debt. Check out our list of the best balance transfer cards for more details.
- Loans. You could also consolidate using a personal loan or home equity loan, the proceeds of which you use to repay what you owe to creditors.
How It Can Hurt Your Credit
Consolidation has many benefits but it can sometimes hurt your credit. This is something you'll want to avoid when possible.
One of the reasons consolidation can hurt your credit score is because it often requires taking out a new loan or opening a new balance transfer credit card, which temporarily dings your credit.
Also, when you get new credit, it reduces the average age of your credit, which can also hurt your credit score because lenders prefer to see a long history of responsible borrowing practices.
Lastly, when you apply for a loan or credit card, you get an inquiry placed on your credit report. As Experian explains, too many inquiries in a short time period are “concerning to lenders,” which means that it could hurt your credit score.
Some people are willing to accept a short-term hit to their credit score in order to take advantage of all the benefits of consolidating credit card debt, but you don't necessarily have to do this — even if you already have bad credit.
There are ways you can consolidate debt without doing damage to your credit score. To do that, here are some key steps you need to take.
Consolidate Debt Without Damaging Your Credit
1. See If You Already Have a Card Offering a Balance Transfer
If you have an existing credit card you can use to consolidate credit card debt, you may be able to avoid your credit being dinged at all.
The only time I've done a balance transfer, I used this approach with an old card that had been open for years. When I signed into the account, I was greeted with a special 0% promotional balance transfer APR offer for 12-months.
For this to work, you'd want to be looking for a few key factors. First, you’d need to have enough available credit on the card to transfer all of the credit card debt you want to consolidate.
Second, you'd want to make sure the card offers you a 0% promotional balance transfer rate for a reasonable length of time — ideally around a year. The Barclaycard Ring Mastercard, for instance, offers 15-months 0% introductory APR and has no annual fee.
Third, you'd want to compare the fees the card charges for a balance transfer. While a 3% fee is common, some cards offer a 0% fee.
2. Limit Hard Inquiries When Shopping Around For Offers
If you don't have an existing balance transfer card to use, you can either open a new card that has the 0% rate and low fees that you're looking for, or you can look into taking out some other kind of consolidation loan.
In any case, when you're applying for new credit, you want to be smart about it. This means when you shop around and compare loan rates among lenders, you should look for lenders willing to pre-approve you and estimate your rate without a hard inquiry on your credit.
💡 Hard inquiries are the inquiries that go on your credit report, as compared with soft inquiries that don't affect your credit score.
Many lenders advertise that you can check out what they're offering before you get a hard credit inquiry. This gives you the chance to make sure you don't get an inquiry for a loan you don't end up taking out in the end.
Along those same lines, you’ll want to avoid applying for cards or loans you know you don't have the qualifications for. If you apply and get rejected, you still end up with the inquiry on your report, dragging down your score for no reason at all.
Apply for just one loan or card that you feel has the right terms and that you have a reasonable chance of being approved for to make sure the consolidation process has the most minimal impact possible on your credit score.
3. Try Not to Max Out Your Card
If you end up using a balance transfer credit card to consolidate your debt, moving your transferred balances over to the card could end up maxing out your line of credit.
If the card is maxed out to nearly 100%, this could cause an issue with your credit utilization ratio. The ideal credit utilization ratio is 30% and below on each of your accounts, so sky-rocketing up to one hundred can greatly affect your credit.
To the lender, they’re essentially seeing you max out a credit card, which makes them nervous that you may not pay it back, causing your credit score to suffer.
This can have a big impact — I recently put some expensive airline tickets on one of my credit cards that brought my utilization ratio to above 50% for one month. The result: my score dropped from 811 to 758 because I was using so much of my available credit. This happened even though my overall utilization ratio across all my cards was still well below the 30% threshold.
Sometimes, it can be hard to avoid this if you aren't given a large enough line of credit on the balance transfer card. If that's the case, you may have to deal with your score falling a little bit temporarily. But, if you avoid maxing out the cards you paid off by transferring the balance, you can at least keep your total overall credit utilization rate low.
And, if you can pay down your transferred balance ASAP, you'll hopefully be able to quickly reduce the amount you owe on the new balance transfer card down below that 30% ratio.
4. Don't Close Old Accounts
Once you have paid off your existing cards with your consolidation loan, you may be tempted to close those accounts so you don't end up hurting your credit score. I know when I paid off all my credit card debt after graduating from college, I didn't know any better and closed several old cards.
It seems like it would make sense not to have those open cards sitting there tempting you to use them, but that’s simply not the case and closing the accounts can be a mistake.
Closing old cards can reduce the total credit you have available, which affects the utilization ratio mentioned above. Plus, it also lowers your average age of credit. While I've earned a high credit score through years of borrowing behavior after college, my short average age of credit is still listed as one of the negatives keeping my score from being higher whenever I check my credit.
If it’s been a while since you checked yours, you can do so for free with Credit Sesame.
5. Pay Off Your Consolidation Loan On Time
It's crucial to pay off your consolidation loans on time. Payment history accounts for 35% of your FICO score, and it’s one of the two most important credit scores you have. Your VantageScore is the other, and payment history is also an important factor in determining your VantageScore.
Most lenders use your FICO or VantageScore when assessing your credit, or have a similar scoring model that also focuses heavily on payment history.
If you pay off your consolidation loan on time, you will develop a positive payment history so your score should go up because of it. You'll also reduce your utilization ratio with each payment you make, which gives your score a further boost.
Consolidation Can Help Your Finances
Researching the ways you can consolidate your credit card debt without having a negative impact on your credit is smart, and you may be able to get all of the perks of consolidation without a hit to your credit.
Be sure to remember these two things:
- You want a consolidation loan with the most affordable interest rate possible
- You want payments you can easily make so there’s no risk of delinquency.
If you can do those things, and pay off your credit card loan consolidation on time, you’ll be well on your way to becoming debt free with a healthy credit score. If you aren’t sure you’ll be able to commit to paying your credit cards off using this strategy, it may be worthwhile to consider working with a debt consolidation company to help guide you through the process.