Debt Consolidation - Texas Mortgage Plan

If you’re trying to keep up with all your debt payments but are increasingly feeling overwhelmed, it may be time for a new strategy. One way to get your debts under control is through debt consolidation. To consolidate debt, start with researching various methods to understand which might work for you.

When done right, debt consolidation can save you money and help you pay off your debt faster. However, some approaches present certain risks to be aware of. That’s why, before you decide to consolidate your debt, it’s important to understand how each method works and if it’s indeed the right choice for you.

How Debt Consolidation Works

When you consolidate debt, you combine multiple debts, such as credit cards, medical bills and other unsecured loans, into one monthly payment with a lower interest rate. It can be an effective financial strategy if you have debt that carries high interest and you are ready to stick to a plan to pay off that debt.

Borrowing From Home Equity

If you have equity in your house, you may be able to use a home equity loan or line of credit (HELOC) to get the cash you need to pay off your other debts. This method is popular because home equity loans and lines of credit offer low interest rates, as they use your home as collateral for the loan. But that’s also where the danger lies: You risk losing your home if you default on your payments.

How Debt Consolidation Affects Credit

In the long run, sticking to your debt payment plan can help your credit scores. However, as you begin to consolidate debt, you might see your scores drop. How long it will take your scores to recover will depend on the consolidation method you’ve chosen.

Here are some ways debt consolidation can affect your credit:

- New credit applications: When you apply for a debt consolidation loan or balance transfer credit card, the lender will check your credit, resulting in a hard inquiry on your credit report. Hard inquiries lower your score by a few points; however, your score should recover fairly quickly.
  Adding new accounts to your credit file also reduces the average age of your credit, or how long you’ve maintained open accounts. This can impact your credit score and is one reason to consider keeping your paid accounts, which contribute to a longer credit history, open. Instead of closing the accounts, put the cards in a drawer or somewhere you won’t use them.

Change in credit utilization: Your credit utilization ratio, or percentage of available credit you’re using, also affects your credit score. The lower your ratio, the better for your credit because this shows you’re not using up all of your available credit. If you keep your old credit cards open after a balance transfer, your credit utilization will likely decrease, benefiting your score. However, keep in mind that even a single card with a high utilization rate—in this case, the balance transfer card you used to consolidate debt—might still have a negative effect on your credit. That’s another reason to avoid incurring new debt on your balance transfer card and putting your old cards away so you’re not tempted to use them.
Debt management plan requirements: Signing up for a DMP may have a negative effect on your credit score as well. Even though the enrollment itself has no impact on credit scoring, your report will show less available credit as a result of closing your credit cards, which is often required by DMP counselors. Your score might experience an initial drop, but will likely recover if you follow the plan.
Settled debts: Of the methods we’ve discussed, debt settlement presents the biggest risk to your credit score because you’re paying less than the full balance on your accounts. The settled debt will be marked as “paid settled” and will remain on your credit report for seven years. The more debts you settle, the bigger hit your credit score could take. In addition, late payments and even collections, which often occur when you use this method, will bring your score down.

Whichever debt consolidation method you choose, the most important step you can take is to maintain a positive payment history by making all your payments on time. This can help your scores recover from short- and medium-term negative effects and even improve in the long run.

Is Debt Consolidation the Right Choice for Me?

Whether debt consolidation is a good option for you depends on your financial circumstances and the type of debt you wish to consolidate. Carefully consider your situation to determine if this path makes sense for you.

When Debt Consolidation Is a Good Option

Consider debt consolidation in these situations:

When you have a good credit score. Having a high credit score can make it possible for you to qualify for 0% balance transfer cards and low interest loans. On the other hand, if your score could use some work, you might not get the terms that would make debt consolidation effective.
But even if your credit score is not perfect, it might still be worth a shot to shop around for debt consolidation loans, as their terms may be better than what you currently have. In the end, what matters is whether it will help you pay down your debt before it gets overwhelming.
When you have high interest debt. Debt consolidation is a good option if you have high interest debt because it allows you to save money by reducing the interest you’re paying.
When you’re overwhelmed with payments. If it’s becoming hard to keep track of your debt payments, debt consolidation can solve that by helping you merge multiple payments into one, making it easier for you to pay on time.
When you have a repayment plan. Having a plan and following it is essential to successful debt consolidation. Before taking the first step to consolidate debt, it’s a good idea to decide on the payment strategy and make sure you’ll be able to stick to it. This may include reviewing your budget and changing some of your spending habits.

When Debt Consolidation Might Not Be the Best Idea

Debt consolidation may not be the best approach in these situations:

When your debt amount is small. Debt consolidation doesn’t make much sense if you can pay off your debt in less than a year. It might not be worth your effort if you’d only save a small amount by consolidating.
When you’re considering federal student loan forgiveness. It’s true that consolidating your student loans can simplify your monthly payments. But if your loans are currently in the direct loan program, consolidation would reset the clock on the 10-year repayment requirement since your original loan wouldn’t exist anymore.
When you’re not planning on changing your spending habits. Debt consolidation isn’t always easy, as it involves finding new ways of saving money and getting rid of the old spending habits. If you don’t think you’re ready to commit, it might not be the right approach to getting out of debt for you.

The Bottom Line

If you’re considering debt consolidation, it’s best to have a Certified Mortgage Planning Specialist (CMPS) prepare a debt repositioning analysis to enable you to carefully evaluate your financial situation and research your options to determine if it’s the right solution for you.

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