10 Warnings to Heed When Consolidating Credit Card Debt
Don’t let bad choices during credit card consolidation put your repayment plans at risk.
Consolidating credit card debt allows you to develop an effective repayment strategy so you can get out of debt faster. At the same time, you minimize interest charges, which reduces your total cost and can lower your monthly payments. But debt consolidation is not a silver bullet. It won’t work in every situation and if it’s used incorrectly, it can actually make a bad situation worse.
So, if you’re considering using consolidation to find debt relief, make sure you’re using it correctly in the right circumstances. Otherwise, you could be looking for a new solution sooner than you’d like. Use the ten points below to give yourself the best opportunity for success.
Warning No.1: Stop making new charges
The biggest mistake people make after consolidating credit card debt is that they don’t stop making new credit card charges. If you’re trying to pay off debt, you need to focus on elimination. New charges just set you farther back from your goal – it’s like two steps forward, one step back.
That’s what happened to Carol. She tried consolidating with a balance transfer credit card, but this zeroed out the balances on her existing accounts. As a result, it was all too easy to start charging again.
Carol from Milwaukee, WI
“I should have left the other credit cards alone once I transferred my balances, but I still needed them to cover basic necessities.”
The right way: Once you consolidate, you need to set up a household budget. The goal is to cover all your bills and necessary expenses with income. This helps you avoid relying on your credit cards to cover everyday needs.
Warning No. 2: Don’t use DIY solutions if you don’t have good credit
In order for consolidation to be effective, you need to reduce or eliminate interest charges applied to your debt. Otherwise, you don’t generate the cost savings you need for this to be an effective way out of debt. So, at minimum, you need good credit score to qualify for do-it-yourself debt consolidation at the right interest rate.
If you don’t have good credit and you try to go DIY, the rate may be too high to provide the benefit you need. Interest charges will eat up every payment you make, making it impossible to eliminate debt quickly or effectively.
The right way: Your goal when consolidating debt should always be to get the interest rate as close as possible to zero. Ideally, you want a rate that’s 5% or less. At most, you need to the rate to be less than 10% in order for your solution to be effective.
Warning No. 3: Don’t convert unsecured debt to secured debt
Most credit cards are unsecured debt. That means that there’s no collateral in place to protect the creditor in case you default. That’s different from secured debt, like a mortgage which uses your home as collateral. In this case, if you default on your mortgage, the lender will take your home and sell it to recoup their losses.
Some people think home equity loans are a good way to consolidate credit card debt. However, this effectively converts unsecured debt into secured. Now, if you fall behind, you can be at risk of foreclosure.
That’s what happened to Carol after her balance transfer solution didn’t work. A creditor advised that she could take out a second mortgage to pay off her credit cards. That just made her debt problems more stressful:
Carol from Milwaukee, WI
“My mortgage payments went up to $2,000… I could barely make the payments, but only if I started charging my day-to-day needs on credit cards again. And out of that $2,000, I was paying over $1,000 a month in interest on the mortgage.”
Luckily, the third time was the charm as Carol looked for another solution. She found Consolidated Credit and we helped her get back on track. Read Carol’s full story:
Carol – When Customers Simply Aren’t Tipping
When your income depends on others because you work in a service industry, things can get tough when the tips simply aren’t coming in as quickly as you need. See how we helped Carol take control of her budget to get ahead.
The right way: Keep unsecured debt unsecured. There are plenty of ways to consolidate that don’t tap your home’s equity. It’s simply not worth it to use a second mortgage solely for the purpose of paying off your credit cards.
Warning No. 4: Be aware of fees and costs to consolidate
In most cases, you should expect some kind of cost associated with consolidating your debt. Some fees are normal. However, excessive consolidation costs only make it harder to reach zero. So, while you should expect some cost, you should avoid high fees when possible.
For example, let’s say you want to use a credit card balance transfer to consolidate. Almost any balance transfer credit card you choose will have a fee that’s applied for each balance transferred. Some have a $3 fee per transfer, while others are 3% of the balance you move. That’s a big difference. If you transfer $25,000, then the 3% card will increase the cost of debt elimination by $750.
The right way: You should expect some fees, but avoid excessive fees when you consolidate. You don’t want to make your journey out of debt any steeper than it has to be. It’s worth noting that a debt management program has fees, but they get set by state regulation. They also get rolled into your program payments, so you don’t actually incur an extra bill.
We got a great question from Phyllis in Secaucus, New Jersey. She was wondering what our fees were for a debt management program, and we get this question a lot.
Fees vary state by state, as well as the person’s budget, the number of credit cards they have, and the amount of debt they have. The fee amounts can run anywhere from $0 to $69 a month.
The setup fee should be the same amount as your monthly fee, and the fee is incorporated into your monthly payment generally, on most debt management plans. And most credit counseling agencies are pretty standard across the board.
Warning No. 5: Don’t be afraid to ask for help
Let’s be honest, most people would prefer to solve their own debt problems without outside help. It’s not easy to let someone into your financial world, especially if things aren’t exactly going well. But using a do-it-yourself solution from a weak financial position is a recipe for disaster.
The right way: If you have more than $50,000 or a bad credit score, consolidating on your own will be extremely tough. You will usually be better off asking for help.
Alex P. from Miami Lakes, AL
I would like to say Thank you for the outstanding service that you gave me. I started the program just four short years ago and in March I will be debt free. With your help in setting better plans with my creditors I was able to accomplish this. It was hard work, but it was all worth it at the end. The Consolidated credit counselors are the best; they answered all of my question(s) and helped me every step of the way.
Warning No. 6: Don’t lose steam halfway through
When people first consolidate, they’re excited that they finally have a solution to eliminate their debt. So, they’re willing to do whatever it takes to reach zero. However, as time passes, it’s easy to get tired of sticking to budget and cutting back. As time passes, you slip back into bad spending habits and can start making new charges again.
With debt management program clients, we usually see this drop-off around the six-month mark. Keep in mind that enrollment in a debt management program is completely voluntary. However, if you drop out your creditors are likely to restore your original interest rates and can even reapply penalties.
The right way: First, choose a solution that gets you out of debt as quickly as possible. Anything longer than 60 payments (5 years) is generally too long to keep up with effectively. And always remember, while debt elimination can be tedious, it’s worth it in the end!
Warning No. 7: Never confuse consolidation with settlement
Don’t confused commercials that offer to “settle your debt for pennies on the dollar” with credit card consolidation. Consolidating credit cards – even with a debt management program – is not the same thing as a debt settlement program.
Debt consolidation always pays back everything you borrowed, to help minimize credit damage. By contrast, each debt you settle creates a negative remark on your credit that remains for seven years after discharge.
The right way: Only consider settlement once you’ve exhausted all other options. It should only be used for debts that are already in collections. And if you’re worried about damaging your credit, just don’t do it!
Warning No. 8: Be cautious with new financing
If you consolidate on your own, then you can seek any type of new financing that you need. If you consolidate through a debt management program, you can qualify for loans like a mortgage or auto loan; however, you can’t apply for new credit cards.
In any case, be very careful with any new financing you take out while you repay consolidated credit card debt. Consolidation often makes it easier to qualify, because it fixes your credit utilization ratio and helps build positive credit history. Those are the two biggest factors used to calculate your credit score.
The right way: Even though you can qualify for a loan, it doesn’t mean that you should apply. Always consider your debt-to-income ratio carefully. If you’re close to your borrowing limit, a new loan could make it tough to keep up with your bills. Ideally, you want your debt-to-income ratio to be 36% or less to make it easy to maintain stability.
Warning No. 9: Check your credit once you eliminate the debt in-full
Once you complete a plan to repay your debt, you should also complete a thorough review of your credit report. Creditor should automatically inform the credit bureaus that your account is paid or current. However, mistakes and errors happen frequently, particularly following a period of financial hardship. That means it’s up to you to make sure your credit report is up to date and that old errors aren’t hanging around.
The right way: Go to annualcreditreport.com to download your credit reports from each credit bureau for free. Then check them for the following errors:
- Make sure account information has been updated to reflect your zero balances.
- If you go through a debt management program, make sure the credit history on each account shows that you made your payments on time.
- Any paid collections accounts should show up as closed; if you negotiated with the collection agency to remove the account in return for payment, make sure it’s gone.
- All your account statuses should be current.
If you find any mistakes, take steps to dispute them.
Warning No. 10: Learn from your mistakes
The last thing you want after all this work is to end up right back in the same situation. So, figure out how to ended up with so much debt and then take steps to adjust your financial habits. That way, once you get out of debt, you can stay that way.
- Set up your budget
- Establish an emergency savings fund to cover unexpected expenses
- Never spend more than 10% of your income on credit card debt payments.
Of course, even the best laid plans can get derailed, particularly after a few years. The good news is that if you end up in the same situation, you can always consolidate again.
Janis – Debt Management Program Déjà Vu
After 20 years of financial freedom Janis found herself facing financial distress caused by credit card debt for a second time. She took a path that she knew would work to help her regain financial stability. She called us.