October 18, 2017
How to lower your credit card monthly payments with debt consolidation
What’s Debt Consolidation?
Debt consolidation means taking all outstanding debt you have at various interest rates, and moving it down to a lower interest rate. This saves you money each month. For example, if you had $10,000 in credit card debt at a 27.8% APR rate, you could pay $548 per month and have it paid off in two years. However, that will cost you $3,148 in interest payments. If you were able to move this loan to a 12.0% interest rate, you could save $1,850 in interest payments.
Below are steps according to the type of borrower you are. If you need a refresher on how to calculate your debt-to-income ratio, click here. Otherwise, select what type of borrower profile below applies to you.
Excellent/Good Credit
- You have a credit score of at least 700o
- You are not behind on any paymentso
- Your debt-to-income ratio is less than 50%
OK Credit
- You have a credit score between 630 – 700o
- You are not behind on any paymentso
- Your debt-to-income ratio less than 50%
Poor/No Credit
- You have a credit score of less than 630 or no credit history at all
- You are not behind on any payments
The ability to consolidate debt depends largely on your credit score. The better your credit score, the more options available to you. However, even if you have bad credit, you may still have better options than the interest that you are currently paying. If you don’t know what kind of credit you have, go to www.annualreport.com and choose one of the credit bureaus. It’s not necessary that you know your exact score – you just need to know the approximate tier that you are in. AnnualReport.com won’t give you your exact score, but it will give you a tier (i.e. Good or Poor) and a history of all positive and negative accounts on your credit report. You can pull this information from one credit bureau each year.
If your debt-to-income ratio is more than 50% – and/or – if you are behind on your current payments and see no way of paying them, it may be time to negotiate with your creditors. This can be done by contacting creditors and offering a payment less than the full amount, but more than zero. Bankruptcy is also an option, but the last one as it will impact your ability to receive credit for years.
Debt-to-Income Ratio
In addition to knowing your approximate credit tier, you’ll want to calculate your debt-to-income ratio (often abbreviated as “DTI”). Talking about ratios may sound scary, but it is really easy. You can do it.
Write down these numbers:
- Debt: The approximate amount of money you pay on debt each montha.
- This includes monthly payments you make on:
- Rent or Mortgage
- Car payments
- Credit cards
- Student loans
- Personal loans
- Child support/alimony
- Do not include utilities (electric, gas, trash), cell phone bills, or credit cards that you pay off every month
- This includes monthly payments you make on:
- Income: The approximate amount of money you receive each month after taxes
- This is just the sum of your paychecks for the month
- Include any alimony/child support or government support that you receivec. If your pay varies significantly each month, take the amount you earn each year and divide by 12
Here is a quick example:
Let’s say you pay rent of $1,600 per month, have a car payment of $200, and have student loans of $64,000. But on those student loans, you are paying $260 each month. You also have two credit cards that you spend about $1,500 on each, but you pay it off every month.
You would add up $1,600 + $200 + $260. This would make your monthly debts $2,060.Remember, you don’t include the entire $64,000 of student loans – just the $260 in monthly payments. And you don’t include the credit cards at all because they are paid off each month. You would only include it if you have interest payments you make on them monthly.
In this example, you work two jobs: as a call center operator during the week and a couple nights per week bartending. Your call center job pays $28,000 per year, but then you receive commission for upsells which add up to another $10,000 per year. Bartending, you make $10 per hour and typically make $150 in tips each night you work.
Select Your Borrower Profile
Excellent/Good Credit
- You have a credit score of at least 700o
- You are not behind on any paymentso
- Your debt-to-income ratio is less than 50%
OK Credit
- You have a credit score between 630 – 700o
- You are not behind on any paymentso
- Your debt-to-income ratio less than 50%
Poor/No Credit
- You have a credit score of less than 630 or no credit history at all
- You are not behind on any payments
Excellent/Good Credit : Balance Transfer Cards
A balance transfer is when you shift all the debt you owe (aka the balance) on one credit card at a high interest rate – over to a different credit card at a lower interest rate. So you owe the same amount of money, you just pay less per month for it. Easy, right?
Not so fast. Balance transfer credit cards are only available to borrowers with good credit, meaning a credit score of at least 700. Some of these credit cards even offer an introductory offer of 0% APR for the first 6-18 months. That’s a heck of a deal. If you had an $8,000 balance on a 22.0% credit card, then you would be paying $320 per month in just interest. Some balance transfer credit cards offer 0% APR for up to 18 months. That instantly saves $5,760 over the next 18 months, and gives you time to pay down the balance.
To see an up-to-date listing of all our favorite balance transfer credit cards, go to: www.brightrates.com/reviews/credit-cards/balance-transfer
So should everyone with high interest debt and good credit pursue a balance transfer? Some reasons you may not want to include:
- Your higher priced debt is on a Citibank card. Citibank does not allow debt to be transferred to another card.
- You will be applying for a mortgage within the next 3 months. If so, don’t apply for any new credit card.
- You are worried that you will spend more money by having an additional credit card.
Ok Credit: Personal Loans
Not everyone will qualify for a balance transfer credit card. If you have credit score under 700 or have a low debt-to-income ratio, then it will be difficult. For these consumers, personal loans from a BrightRates recommended lender will be the best option.
A personal loan is a set amount of money that is borrowed and then paid back within a set amount of time. There are two different type of personal loans:
- Secured loan – A secured loan is on in which the borrower is offering some sort of collateral, or “asset,” which has value. This is most often ownership in a home or vehicle. If the borrower does not pay back the loan, then the lender can take ownership of the asset.
- Unsecured loan – An unsecured loan has no collateral. If the borrower does not pay back the loan, then the lender loses this money. For this reason, lenders of unsecured loans have strict rules around who can and cannot qualify for a loan. Payday lenders are the exception to this rule, but with high interest rates and payments due within weeks, we are not referring to them when we use the term “personal loan.”
For our purposes, we will assume that you do not own any assets to act as collateral, and when we are referring to a personal loan, we are referring to one that is unsecured.
Starting around 2010, personal loans became much more consumer-friendly. Prior to this time, borrowers typically obtained personal loans by physically going to a local bank or credit union. In order to see if the borrower even qualified, the bank would make a hard credit inquiry (read more about hard credit inquiries here). Qualifying was based largely off of FICO score, but knowing the banker sometimes made a difference. If the borrower did not qualify, he had to then drive to a different bank and repeat the process.
The internet has changed all that. Online lenders now allow you to apply online and receive funding in as little as 48 hours. In fact, there have become so many online lenders that sites like BrightRates.com have built features to let you instantly apply at many different lenders and then compare rates. Comparing rates also does not impact your credit score. A hard inquiry is only conducted once you’ve been pre-approved and decided upon the lender you want to use.
How much does it cost?
There are three primary differences among loans that should be understood in finding the best option.
- Interest rates – Interest rates for a personal loan are generally between 8 – 34%. In addition to interest rates, loans vary significantly according to fees and flexibility. Below are some of the most important elements that vary across lenders
- Origination fees – Think of origination fees similar to a setup fee. It is a one-time fee that you pay when you initiate a loan. For a while, many lenders were not charging an origination fee. However, it is now fairly standard to pay an origination fee equivalent to up to 5% of the loan amount
- Early payoff fees – Lenders assume that they will make money for the life of the loan. If you pay off the loan early, they make less money. For this reason, some charge early payoff fees. If a lender charges an origination fee (see above), it is more likely that they will not charge an early payoff fee.
Other differences between personal loans
First and foremost, the personal loan that you are eligible for will vary according to state. Some lenders might be in just a couple of states, while another lender might be in 48 states (I eliminated two – New York and Arizona – because it’s currently virtually illegal to receive an online personal loan in those states). Another difference is the minimum and maximum loan amount. Minimums are generally in the $4,000 range and maximums are generally around $30,000. If you have better credit, you can receive a loan for more. But since we are discussing debt consolidation, if you have that kind of high credit score, you should be pursuing a balance transfer.
Finally, there is the loan duration, or the period in which you need to pay the loan back. The rule of thumb is – the longer the loan duration, the lower the monthly payments, but the greater the interest rate. Said differently, if you have two loans that are the exact same amounts but one must be paid back in one year and the other must be paid back in two years, you’ll pay less cash out-of-pocket each month with the loan due in two years. However, each month, more of that monthly payment will be in interest only. Meaning, when you’ve paid off the loan in two years, you will have paid more in total to the lender or bank.
To see the best person loan for you, go to: www.brightrates.com/personal-loans
Poor / No Credit : Budget & Build
Budget
Many borrowers will not qualify for a balance transfer card or a personal loan. This is usually because they had some negative credit reports in the last 7 years (i.e. late payment) and their credit score is below 630. It could also be because they simply have not applied for credit in the past, and they have what is known as a “thin file.” In the eyes of lenders, having no credit is not much different than having bad credit, though having no credit is quicker for you to establish a positive credit history.
Finally, borrowers may not qualify for a balance transfer card or a personal loan because they have a low debt-to-income ratio. Their debt is too high in relation to the income they earn.
In either case, assuming that you are current on your debt payments, the approach is:
- Budget Expenses – Attempt to increase income and/or decrease expenses in any way possible to pay off a portion of the current debt. The most important thing though is that you ensure your expenses can consistently be equal or less to your income.
- Negotiate with lenders – There are debt settlement services that will offer to help you negotiate with lenders and settle your debt, in exchange for a monthly fee. They provide a valuable service, but it is a service that you can also do yourself by calling each issuing bank that owns your debt.
- Pay down your credit – You want to pay your balances down to a 30% utilization. In our exercise where you listed all your debt, one of the columns was listing the maximum amount for which you were approved. If that amount is $10,000 (which could be from a personal loan, credit card, car loan, etc.) that represents your “maximum utilization.” It’s the most you can borrow. To improve your credit score, you need to be at 30% or less. In this example, that means paying the debt down to $3,000 or less.
Build (with a secured credit card)
Ok, you’ve paid down a little debt. You are current on payments. But you still have a low credit score, so you don’t qualify for anything better than a payday loan. What do you do? It’s time to plan how to build your credit. The most effective way to do this is through a secured credit card.
What’s a secured credit card?
A secured credit card is one that links to a checking or savings account. There are secured cards that require as little as $99. This $99 doesn’t qualify you for much credit, but it is something. You should use the card only on essentials – just as if you were using cash – and it gets paid from the money in the checking account. The benefit here is that these monthly payments are reported to the credit agencies, and over time, they will improve your credit score. This is one of the quickest, most effective ways to improve your credit score. But you MUST treat the card as cash. You cannot spend more than you have, as the interest rates will be high, you will not be able to make payments, and you will instantly being the downward cycle of debt.
Not all secured cards are equal. Make sure you obtain a card from a reputable bank. It should not have any fees or interest rates when spending below your approved credit amount. Also, don’t get confused with a prepaid credit card like Green Dot. These cards are best for people without a checking account who just want to use a substitute for cash. They do NOT improve your credit score. Finally, take note of the interest rate and, if the secured amount is one you can afford, go with one that has a lower rate. However, remember that this shouldn’t be a factor, as you don’t want to pay any interest for this card at present.
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