What is Credit Card Debt Consolidation?
Did you know the average Canadian has nearly $9000 in credit card debt? Did you also know there are currently more credit cards than there are people in Canada? With the rising cost of living and the ever-increasing ease of using credit cards, it is easy to see how people can become overwhelmed with debt.
The convenient system of buy now and pay later can seem like an easy way to handle your purchases. However, more than a third of Canadians often do not pay their credit card bill at the end of the month. Interest rates can begin to add up and quickly become overwhelming.
If you find yourself with high credit card debt or owing money on multiple cards, it can be difficult to figure out how to dig yourself out of this hole.
Credit card debt consolidation is when you have multiple credit cards with high balances that you need to consolidate into one monthly payment. Your current cards have high-interest rates. This makes it much harder to clear the balance, as much of your monthly payment will go towards paying off the interest.
By consolidating your debt, you will only be responsible for making one monthly payment. Additionally, you should have a lower interest rate.
How to Consolidate Your Credit Card Debt
Consolidating your credit card debts can seem like a daunting process. There are a number of options available, and choosing the best one for you can be overwhelming. Paying off your debt can seem like an impossibility when interest rates are often high. It is also easy to get into the unhealthy cycle of only paying your minimum balance and never clearing your debt.
If you are finding your credit card debt unmanageable, there are multiple debt consolidation options available to you. Before you begin the consolidation process, there are some important steps you should first follow.
- Make a list of all of your existing credit card debts. Document the amount you owe on each card and the interest rate.
- Check your credit score. Check which of your debts are having a negative impact. Look at how to improve this.
- Organize your budget. Write down your monthly income and all of your current outgoings. Calculate exactly how much money you can afford to repay each month.
- Work on how to improve your financial practise and plan your spending better. Create a budget and spend smarter.
Below are some of the best options for credit card debt consolidation.
Your Credit Card Debt Consolidation Options
Debt Consolidation Loan
A debt consolidation loan is a loan that combines all of your current debts into one single debt. It reduces your monthly payments and means you owe money to only one lender. A consolidation loan is usually a more beneficial way to consolidate debt if you currently have high interest, unsecured debt. These could be credit cards, store cards and high-interest loans. There are two types of debt consolidation loan options available.
- Secured loan – The amount you borrow is supported by collateral. This means you use your property (e.g. your home, car or valuable goods) to secure the loan. If you cannot make your repayments, the lender can seize your assets. A secured loan will usually have a lower interest rate.
- Unsecured loan – Does not require collateral to support the loan. The interest will usually be much higher. Additionally, the amount you can borrow will be lower. You may have to borrow from an online lender as banks are notoriously difficult to obtain unsecured loans from. Especially if your credit rating is not high.
Debt Management Program (DMP)
You may be feeling overwhelmed by your debt but do not qualify for a debt consolidation loan. A Debt Management Program aids you in repaying your debt within the agreed time frame (typically 3-5 years). You will make one monthly payment to a DMP agency. They will then take responsibility for paying your debtors.
A DMP requires you to repay all of the money that you owe. Make sure you can afford the monthly payments before committing to this program. Be aware that a DMP will remain on your credit file for up to three years after you have completed your payments. This can be perceived negatively by other lenders who may be reluctant to lend you money in the future.
Credit Card Balance Transfer
Do you find it difficult to pay off your credit card because of the high-interest rates? A balance transfer credit card may be a good option to help you clear your debt. This is because they usually offer very low-interest rates for a promotional period. You should aim to pay off the debt before this time ends as otherwise, the interest rate will rise. Below are some of the most popular options available:
- CIBC Select Visa – 0% interest rate for the first 10 months. 1% transfer fee.
- PC Financial Mastercard – 0.97% interest rate for 6 months. No transfer fee or annual fee.
- Scotiabank Value Visa – 0.99% interest rate for 6 months. $29 annual fee.
- Tangerine Money-Back Card – 1.95% interest rate for 6 months. No transfer fee or annual fee.
Home Equity Line of Credit or Loan
Home equity is the difference between how much is still remaining on your mortgage and the value of your house. A home equity loan typically has lower interest rates than other debt consolidation loans. If you decide this is the best option for you, you have the following available options.
- Refinance your home and borrow up to 80% of your equity.
- Get a second mortgage. This loan will be secured against the equity in your home.
- Borrow the amount you prepaid on your mortgage.
A home equity loan gives you a one-time lump sum of money, and you pay interest on this amount.
Home Equity Line of Credit (HELOC) is a form of revolving credit. This means you can borrow money, pay it back and then borrow it again at another time. This is up to a pre-agreed limit. You can borrow up to 65% of your home’s value. However, you can choose how much money to use each time. You will only pay interest on the amount you use.
There are two main lines of credit options available.
- HELOC combined with your mortgage.
- Stand-alone HELOC – These lines of credit are secured by your home but are unrelated to your mortgage.
Why Would Someone Want to Consolidate Their Credit Card Debt?
Making the decision of whether to consolidate the debt you have accrued on credit cards can seem difficult and confusing. Consolidation of debt is not a one size fits all solution, and it does not work for everybody. To help with your decision, we will look at some of the reasons why taking the first step towards debt consolidation could be a good course of action.
Advantages of debt consolidation:
- Reducing your interest rate – Credit card companies are often high-interest lenders. This means if you do not pay off your bill each month, the company will start to charge you high interest. One of the main aims of debt consolidation is to reduce or remove the high-interest rates by opting for a plan with lower interest.
- Having a plan to get out of debt as quickly as possible, rather than allowing the debt to spiral, may prevent your credit rating from falling.
- It can make your debt easier to understand and manage, as you will only be paying one lender a fixed monthly payment.
- You can usually arrange to pay a monthly payment that suits your financial situation. This should prevent you from accruing more debt.
- You can pay off your debt faster as the interest rates will be lower and the monthly payments more affordable.
Credit Card Debt Consolidation and Your Credit Score
People often do not realize how important a good credit score is until they find themselves with a red flag against their name and a score of less than 600. Your credit score is the main indicator that any reputable lending company will use to see if you are a candidate to borrow money.
If you are in need of a loan, but your score is low, you may feel there is no other option but to use a company with extremely high-interest rates.
Debt consolidation could be an important step in raising your credit score. Initially, you may see a decline in your score. This could be for a number of reasons. Every time you open a new loan or credit account, you will see a temporary fall in your credit rating. Do not worry; as long as you make your payments on time, you will see this rise again.
If you make multiple applications for a debt consolidation loan or credit card, you are negatively impacting your score each time. To prevent this, do your research and contact potential lenders to check if you are likely to be accepted. Only then should you complete an application.
Although you may see a further decline in your credit score initially, do not worry. Make your payments on time and continue to stay committed to reducing your debt. You should then see your score rise. The long term effect of debt consolidation should be a healthy credit rating.
The Positive Effect of Credit Card Debt Consolidation
One of the main reasons people choose debt consolidation is to save money while reducing their debt. As mentioned earlier, the main reason this happens is because of a reduction in interest rates. However, there are other benefits to consolidating your debt.
Your financial situation can seem stressful and confusing when you are in debt. It may seem like a never-ending cycle of late fees, more interest being added to your account and rejected payments. Consolidating your debt into one monthly payment can reduce the confusion and help you escape the negative cycle.
You can also prevent further damage to your credit rating. As you have only one monthly payment to focus on, you are less likely to miss a payment or pay late. Unlike other debt payment options, debt consolidation means that you repay 100% of your debts. Therefore there will be no long term negative impact on your credit rating.
Ultimately, debt consolidation should help you get out of debt faster. You should then have the financial freedom to use your money as you wish.
Credit utilization is the amount of credit you have available to use versus the amount you are actually using. For example, if your limit is $5000, and you have used $1000, your utilization score is 20%. Your utilization score is calculated across all of your available credit.
A lower utilization percentage is better for your rating. This is because it shows that although you are being offered a larger amount of credit, you are only using a small percentage.
Credit utilization can affect as much as 30% of your credit score. Having a good utilization percentage demonstrates you are able to manage your spending and make your repayments.
Your utilization percentage only includes your revolving credit. It does not include other loans such as a mortgage, car loan or debt consolidation loan. By monitoring your utilization percentage and aiming to keep it as low as possible, you should see a positive impact on your credit rating.
Being Debt Free vs. Your Credit Score
Finally, paying off your debts and becoming debt-free is a great accomplishment. You now have the financial freedom you were aiming for and do not have to worry about big monthly payments. However, a common concern of many people who are now debt-free has no debt, or no monthly payment commitments can actually harm your score.
You shouldn’t have to make the choice between being debt-free and having a good credit rating. Unfortunately, one of the ways your score is calculated is by looking at how you handle debt. Having no debt does not result in a bad rating. However, you may find your score is not very high either and just hovers in the ‘good’ range. This wouldn’t be too much of a problem unless you plan to apply for a big loan, such as a mortgage.
The key is to balance keeping your debt minimal with maintaining your high credit score. Using your debit card will have no effect on your credit rating. This is because you are essentially spending your own money. If you use a credit card, you are borrowing money, even if only for a short time. This will have a positive impact on your credit score. If you decide to pursue this option, ensure you make regular payments and do not allow any interest to accrue on your account.
The Bottom Line
Consolidating your credit card debt can seem like an overwhelming process. Deciding whether it is the right option for you can be difficult. To help your decision process, look at what your monthly payments currently amount to. How much are you paying in interest, and how long will it take you to clear your debts? Also, look at the impact it is having on your credit rating.
If you decide debt consolidation is the best option for you, ensure you keep up with the monthly repayments. By recognizing your debt could be an issue, you are already one step closer to financial freedom and becoming completely debt-free.