How to Protect Your Credit Score During Debt Consolidation

How to Consolidate Credit Card Debt Without Hurting Your Credit

Consolidate Credit Card Debt Without Hurting Your Credit ScoreIf you’re considering debt consolidation as a path out of your current budget dilemma, chances are your credit already is bruised. Nonetheless, you can reduce credit card debt, even achieve debt-free nirvana, without ruining your credit long term.

Reduce Credit Card Debt Without Ruining Credit

If you’re not in big trouble, getting on top of your debt may be as simple as re-evaluating and rejiggering your budget. (You do have a budget, don’t you?)

Make a journal of your monthly and other periodic expenses. Be honest. Include every penny you earn, and every penny you spend. There are wonderful budget apps to help you achieve this first step, many of them free.

Conquer Your Debt

Debt management can help you conquer your debt and manage your household budget

Once you have a precise picture of where your money goes, search for places to economize. Almost everyone has some low-hanging fruit. Chances are, you can achieve savings on non-necessities such as your:

  • Mobile phone package. (Call your provider and ask for a better deal.)
  • Cable and internet provider. (Ditto. If you’re on a contract, shop when it’s about to end.)
  • Streaming services.
  • Vehicle and homeowners/renters’ insurance. (Ask your agent about a better deal. Shop around as renewal approaches.)
  • Eating out.
  • Coffee shop addiction.
  • Driving habits. (Accelerate as though there’s an egg between your foot and the gas pedal. Every fresh green light is not an invitation to test your vehicle’s ability to get from zero to 60.)
  • Review your subscriptions for items and services that are on autopay.
  • Avoid impulse purchases.
  • Wherever possible, adopt cash-only budgeting. Investigate the cash-envelope budget method.

Once you’ve stopped whipping out plastic for every purchase, every dollar you save is a dollar that can be plowed into reducing your credit card debt.

Experts have identified two principal ways to attack credit card debt.

  • The debt snowball takes its name from the way consumers develop momentum by picking off balances from lowest to highest. Experts point to the inspiration to keep going that comes from reducing accounts to zero.
  • By contrast, the debt avalanche method advocates attacking the balance with the highest interest rate first, no matter what the balance, followed by the next highest, and so on, all the while making timely minimum payments on your other debts.

The best, surest way to reduce debt without harming credit is by making full, on-time payments. If keeping up with even the minimum payments is a problem, credit card debt consolidation is an option.

Does Debt Consolidation Hurt Your Credit?

Debt consolidation describes a basket of methods to reduce and eliminate what a consumer owes. The ones that won’t crush your credit rating include:

  • Consolidation loans from a bank, credit union, or online lender.
  • Balance transfer(s) to a new low- or zero-rate credit card.
  • Borrowing from a qualified retirement account, such as an IRA or 401(k).
  • Borrowing against the equity in your home or something else of substantial value.
  • Borrowing from a friend or family member. (This, plainly, is in almost all circumstances an act of desperation; avoid it if you possibly can.)
  • Working with a nonprofit credit-counseling organization.

Each of these, carried out properly and successfully, will stabilize and, over time, improve your credit score.

Then there’s debt settlement.

1. Debt Settlement: How It Affects Your Credit

By contrast, debt settlement will wreak havoc on your credit score. Yes, even if you’re behind on your payments and maxed out on your credit lines, debt settlement — a method that seeks to get you off the hook for less than you owe — can cause your rating to plummet.

Successful debt settlement also includes potential income tax ramifications; the IRS will regard forgiven debt as regular income in the year the settlement, well, settles. In short, consumers trade one hook for another.

So, when you hear others say debt consolidation will “ruin your credit” this is the type of consolidation they are talking about. You’re attempting to wriggle out of what you promised to repay. Of course you’re going to get dinged.

And those blemishes stick around just as long as bankruptcy: Seven years.

Debt settlement in a nutshell: You, or someone you hire, attempts to persuade your creditor(s) to accept as payment in full something less than payment in full. Don’t be fooled by radio commercials that claim you “have a right” to settle your debt for less than you owe. No such right exists.

If your negotiations are successful, you will, indeed, pay less than what you owed. If you hired a debt-settlement company, you’ll also have to fork over a percentage of the total debt when you approve the settlement. (Pay nothing — zip, zero, squat, diddly — up front.)

When the settlement is reported to the Big Three credit-tracking agencies, your rating will sink like the Lusitania, dropping almost as much as if you’d declared bankruptcy. Settle one card and your score can plummet from 45 to 160 points, depending on your credit health going in. Settle multiple accounts and you’ll suffer even more damage.

And those blemishes stick around just as long as bankruptcy: Seven years.

In fact, having an account marked “settled” is only slightly better than “unpaid.” Any status besides “paid as agreed” or “paid in full” will injure your credit.

Which is why, instead of debt settlement, you should consider …

2. Debt Consolidation Loan: DIY Pitfalls

A personal loan — from a bank, credit union, or online lender — large enough to cover all your high-interest credit card debt is worth looking into, for several reasons. Among them:

  • Your credit score could get a boost. A personal loan is an installment loan. That is, you won’t continue to add to the balance; you simply will pay it off over time. Zeroing out your credit cards with a consolidation loan will help your credit score’s health, as will making on-time payments and the mix of credit, two major portions of a credit score.
  • You will trade several monthly due dates for one, possibly for a lower payment than all your credit card minimums combined.
  • You probably will save money. Personal loan interest rates tend to be lower than credit card rates, often by half or more.

Pro Tip I: Once you have used your personal loan to pay off all your credit card debt, do not close those card accounts. At least, keep open the ones that don’t have annoying annual fees. Debt usage and average age of accounts are key components of your credit score. The Big Three credit-reporting firms regard having lots of room on long-open cards as a sign of credit worthiness.

Pro Tip II: Those credit card accounts you’re going to keep open? Avoid using them. Freeze them in a block of ice. Lock them in a safe deposit box in a bank across town. Cut them up if you must. If you’re an internet shopper — who isn’t? — methodically delete, delete, delete the cards you’ve saved on online retailers’ sites.

OK, keep one all-purpose card for those moments when cash simply cannot be used, such as reserving a hotel room or renting a car. But make sure there’s room in your budget to pay in full whatever balance arrives in the next billing cycle.

The thing about a debt consolidation loan — as wonderful as its potential for righting what’s been wrong in your financial life — is it won’t cure what’s been wrong in your financial life.

Without a firm, strict, downright religious commitment to changing the habits that led to your alarming debt load, a consolidation loan can, in short order, turn into nothing more than a temporary relief valve.

Once the consolidation loan is in place, you’ll need reverential discipline — which, let’s face, isn’t much fun and is hard even on saints — to change the spendthrift practices that threatened to overwhelm you in the first place.

Continued poor money management could put you right back where you were before, only with an installment loan demanding its monthly feeding. Miss those payments, and your credit score will crumble.

3. Debt Management Plan: For Long-term Credit Health

If debt settlement sounds scary, but you don’t trust yourself not to make a mess of things in a post debt-consolidation-loan life, you could be a candidate for a debt management plan through a nonprofit credit counseling agency.

Begin by finding a reputable credit counseling agency, like InCharge Debt Solutions. The U.S. Department of Justice keeps a state-by-state list of approved credit-counseling agencies.

As with most any professional service, you will want to interview a handful of candidates. Ask each the same set of questions. Get a firm idea of what their proposals entail; commit to no plan until a reputable counselor has thoroughly scrutinized your financial fix with you.

When you have identified the counselor, agency, and program that fits you best, get on with it.

Unlike a debt-consolidation loan, your balance(s) will not go to zero overnight. Moreover, a key part of most debt-management plan is the closing of unsecured-debt accounts. Yes, your credit rating will take a bit of a hit for six months or so. But that’s OK — seriously — because, as part of the plan, you’re not going to be seeking to add new debt anyway.

The counselor will work with your creditors to see about reducing interest rates, monthly payments and waiving fees.

When your agent has come to terms with all of your creditors, you will begin making monthly deposits with the debt-management organization, money it will use to pay your unsecured debts.

You will be in this for the long haul, maybe three to five years. During that time, your credit report will carry a notation that you’re in a debt-management plan; this is an alert to creditors you weren’t able to live up to your earlier commitments.

However, at the end of the DMP, the notice vanishes with no lasting effect; your score will have benefited by a steady series of on-time payments; and you will be absolutely ready to start afresh, with the knowledge gleaned from your credit counselor, and the experience of having conquered your debt monster.


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About the author

Tom Jackson focuses on writing about debt solutions for consumers struggling to make ends meet. His background includes time as a columnist for newspapers in Washington D.C., Tampa and Sacramento, Calif., where he reported and commented on everything from city and state budgets to the marketing of local businesses and how the business of professional sports impacts a city. Along the way, he has racked up state and national awards for writing, editing and design. Tom’s blogging on the 2016 election won a pair of top honors from the Florida Press Club. A University of Florida alumnus, St. Louis Cardinals fan and eager-if-haphazard golfer, Tom splits time between Tampa and Cashiers, N.C., with his wife of 40 years, college-age son, and Spencer, a yappy Shetland sheepdog.