Stacked credit cards


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Have you ever just stared at your credit card bill and thought, "Wow, this has gotten a bit out of hand, hasn't it?" It happens to the best of us. When it comes to managing debt, however, making informed decisions that won't adversely impact your credit score is key.

While some people may be tempted to close credit cards as a means of getting their financial situation under control, there's an alternative that won't further impact their credit score: consolidating debt. Consolidation offers several advantages over closing credit cards — particularly when it comes to preserving your credit utilization ratio and maintaining a longer history of open accounts (both of which are important to cultivate better credit). 

But what exactly is debt consolidation, and how does it work? We did a deep dive to help you make an informed decision.

Drowning piggy bank in water, symbolizing debt crisesPhoto credit: photoman/istockphoto

What Is Debt Consolidation?

Debt consolidation means taking multiple debts — often from different creditors — and merging them into one loan. Think of it as gathering all your debts and tying them together with a big red bow. It's not just about making your debt look pretty, though. Consolidating debt means you could snag a lower overall interest rate, which can save you a pretty penny in the long run. It also means you'll have just one monthly payment to deal with, which can simplify and improve your financial management. 

Furthermore, debt consolidation offers the opportunity to create a more structured repayment plan to help improve your credit. This can help you regain control over your finances and make steady progress towards becoming debt-free. With a consolidated loan, you have a clear roadmap for repayment — making it easier to budget your monthly expenses and stay on track. 

What About Closing Credit Card Accounts?

On the flip side, what about closing credit cards? You might think, "Out of sight, out of mind," right? But unfortunately, it's not that simple. Closing a credit card with a balance on it does not erase the debt, and can even result in unforeseen consequences that could impact your credit standing and hurt your financial health. Here are two main reasons:

  • Credit Utilization Ratio: Your credit utilization ratio plays a significant role in your credit score. It's the amount of revolving credit you're using divided by the total amount of revolving credit you have available. Simply put, if you're using $1,000 of your $10,000 available credit, your utilization ratio is 10%. If you close a card, and that total credit limit decreases, the ratio goes up. Higher utilization ratios can negatively impact your credit score because it signals to lenders that you're overly reliant on credit, which makes you a high-risk borrower. 

  • Length of Credit History: Another factor that influences your credit score is the length of your credit history. The longer your accounts have been open and in good standing, the better. When you close a credit card, especially an older one, it could potentially shorten your average account age. This could result in a lower credit score.

However, that's not to say you should never close a credit card. There are certain cases where closing a credit card outweighs the disadvantages. If the card carries high annual fees or maintenance costs, or if you find it challenging to manage multiple credit cards, closing one can help simplify your financial situation. That being said, closing credit cards is typically not the best choice when you're looking to get on top of your debt situation.

Depressed Asian young girl feel worry about financial problem in house. Stressed desperate young woman looking frustrated to paperwork and bills think of money debt, budget loss, bankruptcy at home.Photo credit: Kiwis/istockphoto

When You Should Consider Consolidating Debt

According to one user on the r/PersonalFinance subreddit, consolidating debt works best if you can first get your spending under control. "It’s a good idea on paper. But one thing I want to mention, as someone who has done this: please get to the bottom of your spending before getting a consolidation loan. I didn’t change my spending habits and ended up filing for bankruptcy several years later. You don’t want the loan and credit card balances again."

It's also important to note, however, that debt consolidation is not a magic solution that eliminates your debt entirely. Consolidation involves combining multiple debts into one, often with more favorable terms (though higher interest rates can also apply). While it can make getting out of credit card debt more manageable, it does not erase the debt itself — and successful debt consolidation requires discipline and responsible financial habits to avoid getting yourself into a deeper hole. 

"A debt consolidation can help you lower your monthly payment and help improve your credit, but only if you stick to a plan to pay down your debt," says Eric Rosenberg from Credit Karma

If you're facing any of these situations, consolidating debt might be a good solution:

  • Managing Multiple High-Interest Debts: If you find yourself juggling multiple high-interest debts, such as credit card balances, personal loans, or payday loans, consolidating your debt into a single loan with a lower interest rate could be an ideal option. By doing so, you can simplify your payments, potentially save on interest charges, and have a clear repayment plan.

  • Improving Cash Flow and Monthly Budgeting: If your current monthly debt payments are straining your cash flow and making it difficult to manage your finances, debt consolidation can provide much-needed relief. By combining your debts into one manageable payment, you can free up cash flow, create a more realistic monthly budget, and gain better control over your financial situation.

  • Simplifying Debt Management and Tracking: When you have multiple debts with varying due dates, interest rates, and lenders, keeping track of payments can be challenging. Debt consolidation streamlines the process by merging all debts into a single loan, which can be a more organized approach to help manage your debts. 

"I consolidated about $30k [of credit card debt] into a 5-year personal loan. Paid extra and got it paid off in 3 years. This is the way," writes another Redditor. 

The Bottom Line

Debt consolidation can be a smart way to manage multiple debts and potentially lower your overall interest. Closing credit cards — while it might seem like a good idea — could have the unintended effect of negatively impacting your credit score. Like many things in life, the key lies in finding the right balance that works for you. 

Remember: Everyone's financial situation is different, and what works for one person might not work for another. When in doubt, it's always a good idea to speak with a trusted financial advisor or counselor who can help tailor advice to your specific circumstances.

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