The holidays are perhaps the easiest time of year to rack up large amounts of debt on your credit cards. Between the pressure to purchase gifts for everyone you know and the constant sales tactics – buy Buy BUY! – a credit card can go from zero balance to maxed out within weeks, or even days. If you find yourself in this situation post-holiday, then there’s no magic solution to making those balances disappear.
However, you may find that a debt consolidation loan will get you on track to paying them down faster. Debt consolidation loans are personal loans that are specifically earmarked for repayment of existing debt. For instance, instead of having three credit cards with varying interest rates and payment dates, you could pay them off in exchange for just one debt consolidation loan. Follow these steps to tackle your holiday-induced credit card debt.
Consolidate Debt at a Low Rate
A debt consolidation loan generally makes sense when you’re having difficulty keeping up with multiple credit card payment dates, and when you can qualify for a lower interest rate through a consolidation loan than you’re currently paying with your various cards. However, watch out for fees or other terms that can make a loan a worse deal, and don’t use a loan that offers a higher interest rate than the combined rate of your cards.
Remember that you’ll want to use the weighted average of your credit card interest rates. If you’re paying 10% interest on a $2,500 card balance and 20% interest on a $500 card balance, then a consolidation loan for $3,000 at 15% interest is not a good deal for you. That’s because the weighted average on your cards is just 11.67%.
Even though the interest rate on the proposed consolidation loan is a split between your two prior rates, you’re really paying more interest overall because the rate will have risen on most of your lower rate balance. Search online for “weighted interest rate calculator” to determine what rate you’re really paying across all credit card balances combined.
After that, look for a consolidation loan with an interest rate that saves you money. If a relative or close friend with excellent credit is willing to be your cosigner, then that can save you even more money. You could also consider using a promotional balance transfer offer to lower your interest rate on your credit card debt.
Look for a Loan That Will Pay Your Creditors Directly
Having an available credit line is tempting – after all, isn’t that how most of us get mired in credit card debt to begin with? For this reason, look for a lender who will pay off your credit card debt directly instead of simply making a new line of credit available to you. Also, ask your lender if they will limit your credit line to exactly the amount necessary to pay off those cards and not a dollar more.
This will make it less likely that you’ll find reasons to use any of the new line of credit for things other than paying off the cards. If your lender will only extend a line of credit in round amounts such as by the thousand or hundred, then you’ll just have to exercise extra willpower to avoid taking any of that money out – and repeating the cycle that got you there in the first place.
Consider Closing Your Credit Lines Once They’re Paid Off
This step is up for debate since closing established lines of credit will in most cases drop your credit score. Part of your score is based upon the average length of time all your lines of credit have been open (your average account history length) and eliminating credit cards and loan lines of credit that have been open for a while can cause that average length to become shorter.
However, this should be weighed carefully against the odds that with those cards and loans still open, you’ll rely upon them again and get back into debt.
A reasonable compromise might be to close all but the one or two that have been open the longest; this way minimizing the damage to your score while still leaving yourself with an emergency card or two. It’s also possible to call up your credit card companies and ask them to decrease your credit card limit. This is great for two reasons.
One, it won’t affect your credit score by decreasing your average credit history. Two, the portion of your credit score that is based upon use of your cards and other loans is based upon utilization by percentage – meaning your score is affected equally whether you use half of a $500 card or half of a $5,000 card. So, you can safely lower your card limit without worrying that your credit rating will drop.
One last bit of advice: the old adage “out of sight, out of mind” really applies well to credit cards. While it’s smart to maintain one or more cards for a variety of reasons (credit score, emergency use, etc.) it isn’t necessarily smart to give yourself easy access to them. Once you’ve got your debt under control using a consolidation loan or by other means, you should keep those cards in a safe place, and you should only take them out when you really need them.
Author: Jeff Gitlen
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