MCP Help Blog

It comes in the mail. It has lots of exclamation points on it, so it must be GOOD!!!! It comes with a CHECK. Pay off all your bills! Consolidate your credit cards to one monthly payment!

Replacing all those credit cards and consumer loans with a single loan MUST be good for your credit, right? And a lower payment means you’ll be saving a bundle too! Right?

Maybe not. Remember, the big print giveth and the small print taketh away. Trading in several monthly payments for one isn’t a legitimate reason to replace those debts with a new one. Consider the following:

1. Paying off and closing out accounts may hurt the “utilization” part of your credit score. For example, if you have 5 accounts with a total limit of $5,000, and you owe $3,000, you are utilizing 60% of your available credit–not great, but not too bad either. By closing those accounts out and replacing them with a $3,000 consumer loan you now have 100% credit utilization. So, you say, maybe I’ll just leave the old accounts open? If you have the discipline to refrain from tapping them while that $3,000 account remains open, that’s an option….as long as the bureaus don’t then ding you for having too many open accounts.

2. Consolidation could cost more. A lower monthly payment isn’t really “savings” unless you are getting a lower interest rate too. And stretching out the debt over too much time can cost you more in the long run even if you get a lower rate. Suppose that you have a $10,000 car loan at 7%, and you have been paying on it for a three years and you now owe $4,000. Your payment is $198.01 and you will have it paid off in 2 more years. Now, some pretty, exclamation-point-loaded mailer shows up, you bite and call the 800 number, and the sales agent tells you (in a very sexy voice!) that you can use that check to pay off the car loan and your payment will only be ONE THIRD as much!!!!! Well, Slick, if you use that check your payment will drop to $57 all right, but only because your $4000 has been stretched out into a ten year loan! And your interest rate just went to 12%!

3. The consolidation loan may have “teaser” provisions. In other words, just because your balance transfers start with a low fixed rate doesn’t mean they will stay that way. Especially if the consolidation loan is another credit card or unsecured account, the terms can probably change whenever the lender chooses to change them. Read the entire agreement and make sure you aren’t jumping out of the frying pan and right into the fire.

Consolidation loans, carefully chosen, can be life-savers. There is a reason for their popularity–the right one can indeed lower your interest, give you a manageable payment, and help you get your financial house in order. The best consolidation loans are those secured by equity in your home. Unlike most other loans, mortgages are highly regulated. Rates can’t be changed arbitrarily, and if you get a fixed rate loan your rate and payment will not change. This makes budgeting easier. Mortgages may also confer some tax advantages–check with an advisor to be sure. And because they are secured by property, debt consolidation mortgages are considered less risky by lenders and rates should be considerably lower than for the unsecured debt you will be replacing. For best results (from a credit rating standpoint), keep a few old accounts (the ones with the best payment histories) open but destroy the cards and don’t use them. You want your credit report to show low credit utilization. Make that monthly payment on time and get used to budgeting. Eventually you’ll get the loan paid off and can divert that monthly amount into savings.