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4 questions to ask before getting a consolidation loan

Erica Sandberg

January 19, 2016

QHi Erica,

I was at Wells Fargo where I have my checking and credit card ($8,000 balance). The man who was working at the time asked if I wanted a consolidation loan. He said the interest rate would be less than the interest on my credit card (24.9 percent). Will it be better or worse for my credit to take a loan like this, and do you think I should do it? I'm so confused.  — Emily

ADear Emily,

To clear up the confusion, use the following checklist. Transferring your credit card debt to a bank consolidation loan makes sense if you can answer yes to these four questions:

1. Will you qualify for the loan? The person you spoke with mentioned the merits of the debt consolidation, yet unless you apply, you won't know if you actually can get it. You'll need to meet the credit and income requirements. If your credit rating is poor, it is unlikely that the bank will greenlight your loan.Ask Erica

Check your FICO score from at least one of the credit reporting agencies — TransUnion, Experian and Equifax. These scores range from 300 to 850. Most lenders prefer to do business with people with FICOs in the mid-700s and above, and are hesitant to lend to those with scores less than 600. You can pull your credit score for about $20 from myFICO.com.

When you complete the application you'll list your income. If you appear to make enough to pay the loan and the source is steady, that's great. If  not, the bank will back off.

2. Will the money you save be worth it? You don't mention how much you're currently sending to the credit card company. (Are you sending just the minimum payment or a fixed sum over and above what is required?) You also didn't mention  the terms of the loan, such as the number of years and the interest rate. As a result, I can't calculate exactly how much you could save, but I can give you some sample scenarios:

Credit card: 24.9% APR declining payment

  • Payment beginning at $240
  • Out of debt in 25 years
  • Total interest paid $16,677

Credit card, 24.9% APR fixed payment

  • $240 every month
  • Out of debt in 4.8 years
  • Total interest paid $5,750

Consolidation loan, 11% APR fixed payment

  • $174 monthly payment
  • Out of debt in 5 years
  • Total interest paid $2,436

Consolidation loan, 11% APR fixed payment

  • $262 monthly payment
  • Out of debt in 3 years
  • Total interest paid $1,428

Ask the lender for the consolidation loan's terms so you can conduct a realistic, side-by-side comparison to determine if you would come out ahead.

3. Will the new monthly payments be easily within your reach? If the loan has an especially short payoff term, the monthly payment will be larger than the expected minimum payment for the credit card. You must be sure you can afford that amount without undue hardship not just every month, but for the number of years of your consolidation loan.

4. Do you have the willpower to not charge anymore on the paid-off card? When you pay off your card with the consolidation loan proceeds, the balance on that card will read $0. An open line of credit can be tempting. If you used the card to pay for things you couldn't afford before, you might do so again. Then you'll run up the card, resulting in more debt and two bills to pay (your consolidation loan AND your credit card bill) instead of one.

As for your credit rating, adding a loan to your credit mix can help your credit score, as having a variety of well-managed credit products is considered healthy. You'll also decrease your credit utilization by having a zero balance on your card, which is also good for your scores. However, your score will take a minor, temporary hit when the bank pulls your credit to see if you qualify for the loan, but that will recover over time..

So, if the answer to all four questions is yes,  I say go for it!

Got a question for Erica? Send her an email.

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