Consolidating credit card debt can dramatically increase credit scores, study suggests

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Experts weighs out the pluses and minuses of different ways to tackle the situation

A new study suggests that consolidating credit card debt can be a shrewd move that can pay off in several ways. In addition to the belief that paying off bills in time can improve credit scoresLendingTree’s latest analysis of the yays and nays of credit card consolidation found that those who consolidated at least $5,000 in credit card debt found their credit scores rose an average of 38 points in as little as a month. 

In fact, the study concludes that the more credit card debt someone pays down with a personal loan, the higher their credit score jumps. Let’s say you pay down $10,000 or more in credit card debt. In that case, credit scores go up an average of 49 points. The inverse is true, as well. The study found that taking out a loan to pay down anywhere from $1,000 to $5,000 in credit card debt, borrowers gained an additional 17 points, on average, in a single billing cycle.

While taking out a personal loan to pay down credit card debt can seem a bit like robbing Peter to pay Paul, LendingTree chief credit analyst Matt Schulz said it’s definitely worth the effort.

“A higher credit score is a big, big deal because there are few things in life that are more expensive than crummy credit,” Schulz said. “It can cost you thousands of dollars in the form of higher interest rates on loans, higher insurance premiums and more. It can even keep you from getting that new apartment you’re hoping to rent.”

But Schulz cautioned that even though credit card debt consolidation will likely cause someone’s credit score to go up, there’s more upside to eliminating debt altogether.

“Eliminating that debt can be nothing short of life-changing,” Schulz said. “It can free you up to build an emergency fund, save more for retirement, work toward buying a home or paying for your kids’ college. It’s a big, big deal.”

Where to get the consolidation loans and what to consider

Schulz said that for consumers who have the highest incomes and the best credit scores, getting a personal loan from a bank is the best way to go. “These are probably folks with significant experience with lenders and at least a few other items on that credit report. Those folks have a lot of other data points on their credit report that are influencing their credit score, so one change, even a big one like paying down all that debt, may not be as impactful for them as it would be for someone newer to credit,” he said.

ConsumerAffairs investment advisor Barbara Friedberg agreed. She said that the most clear-cut way to obtain a debt consolidation loan is through a bank or other debt consolidation lending institution. 

Friedberg said that if consumers can’t – or don’t want to – go the bank route, there are three other ways to get out of credit card debt.

0% balance transfer card: Balance transfer credit cards allow consumers to consolidate their debt by transferring the debt of multiple credit cards to one balance transfer card. Friedberg notes that some of those cards include 0% interest offers along with sign-up bonuses and cash-back rewards.

Home equity loan: “Homeowners can take out an amount of money based on the equity they have in the home, determined by the amount of money paid into the mortgage over the value of the home,” Friedberg said, adding that a home equity loan can be taken out to make home improvements, pay large bills or settle other debts.

401(k) loan: One unique approach Friedberg offered is for people who have a 401(k) set up through their employer. For those folks, they can borrow against that account. “Because a 401(k) is a personal retirement savings account, this is essentially borrowing from yourself. Because you’re withdrawing money from an account, not borrowing new money, a 401(k) loan will have no impact on your credit score. 401(k) loans typically require full repayment within five years,” she said

That 401(k) loan idea comes with a warning flag, though. Friedberg said that, most likely, there will be a small interest tacked onto a person’s repayment plan, and they also risk hurting their overall retirement savings plan. For those whose jobs may be shaky, Friedberg raised her warning a little higher. “If you lose your job, you’ll be required to pay back the 401(k) loan by the time your federal income taxes are due for the year,” she said.

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