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Your debt has been piling up for a while and you’re wondering how you’re ever going to pay it off when a letter arrives touting a zero percent interest rate if you transfer your credit card balances. This looks really good – almost too good to be true — so you’re left wondering is consolidating credit cards a good idea? Will it help or hurt your credit rating?
Well, let’s take a look.
What Happens When You Consolidate Debt
As the phrase implies, you’re basically taking a bunch of separate financial obligations, rolling them into one, and paying them all off simultaneously. In essence, you’re taking out a new loan with which you’ll pay off your old ones.
It can work, but you do have to be careful to do it the right way.
What’s The Right Way?
At first glance it can seem kind of backward to go deeper into debt when you're trying to get out of it. However, getting a consolidation loan doesn’t have to mean going deeper into debt, even though that’s exactly what will happen if you’re undisciplined.
The moment you use the funds from the consolidation loan to pay off your existing debts, you’re going to have a lot of open accounts with zero balances. You’ll also have a pretty substantial new debt to pay off.
Meanwhile, those newly freed-up accounts are luring you to slide deeper into debt. Go for the okie-doke and you’ll be in a way deeper hole than the one with which you started. Simply put, you have to stop charging things when you take a consolidation loan if you want to have any chance at all of paying it on time.
Depending upon the type of credit card consolidation you do, there are some other areas in which you’ll need to be careful. The biggest one is making sure the consolidation loan you take will be sufficient to pay off your outstanding debt, but small enough for you to service it comfortably.
Zero Percent Offers — You’ll have to make sure paying off the amount you transfer is doable within the time frame allotted with an introductory deal. You might find yourself in a situation in which you’ll owe the lender interest payments on the total amount transferred — going all the way back to the date you signed the loan — if you can’t pay the balance in full before the deal expires.
Is the Overall Deal Better? — You’ll need to do the math to ensure you’ll come out ahead when the loan term, associated fees and interest rate are taken into consideration with a traditional consolidation loan. You’ll generally get a lower monthly payment and a longer time period to pay. However, if the fees, along with the interest rate multiplied over that time period will make your debt larger, staying with your current situation might be a better move.
Secured vs. Unsecured Debt
A credit card balance transfer will trade unsecured debt for unsecured debt. However, taking a personal loan for which you pledge some form of collateral means trading unsecured debt for secured debt.
That collateral could be in the form of a home, a car, a boat or some other item of value such as stock certificates, bonds or what have you. Whatever it is, you’ll be forced to liquidate that property to satisfy the debt if things go sideways and you’re unable to pay as agreed. This could mean losing your home if you go with a home equity loan or line of credit.
So, is consolidating credit card debt a good idea?
Well, yes and no. Fall victim to any of the above pitfalls and you’ll be in worse shape than when you started. However, it can be a smart play if you’re careful to take note of the caveats we’ve outlined above and avoid them.