Americans historically lose financial ground and stack up debt in recessionary environments, and that’s what seems to be happening already at the mid-point of 2022.
According to a new Forbes survey, Americans have added $266 billion in household debt from the fourth quarter of 2021 to the first quarter of 2022, with two-thirds of consumers saying they’re “blowing through savings” as the price of just about every commodity churns upward.
That scenario leaves consumers vulnerable to a lower credit score and weaker leverage, as good credit is hard to get when a FICO credit score sinks below 660 or so.
That scenario is a harsh reality, too, according to Transunion. The credit scoring firm says that credit card balances and consumer debt delinquency rates are rising among Americans with a credit score below 660.
“If high inflation persists, the study projected delinquencies could rise to about 8.4% of total credit card loans by the first quarter 2023, up from 8% in the first quarter this year, TransUnion reported.
That would make consumer credit scores sink even further.
One Way to Boost Credit Scores
Consumers looking to cut personal debt often do so by consolidating multiple sources of debt into a single personal loan.
While that can make reducing debt easier, as long as the borrower aggressively pays the loan debt down, there’s also an under-the-radar benefit -- it can boost your credit score, too.
That sentiment comes from a new study from Lending Tree, which found that consumers who used a personal loan of $5,000 to consolidate credit card debt added an average of 38 points to their credit score in a single billing cycle.
How is that possible?
The study, which tracked more than 1,500 anonymized LendingTree users who used a personal loan to consolidate credit card debt, examined how their credit scores were impacted one month after they took out a personal loan to pay off credit card debt.
In total, here’s what the study found:
Using a personal loan to pay down credit card debt can boost your credit score substantially. Consumers who used personal loans to pay off at least $5,000 in credit card debt saw their credit scores rise an average of 38 points between the month before the loan was originated and the month after, when it first appeared on their credit report.
The more credit card debt you pay down with a personal loan, the higher your credit score jumps. For example, paying down $10,000 or more in credit card debt with a personal loan increased credit scores by an average of 49 points.
Paying down lower amounts can still net a double-digit credit score increase. The report found that paying down between $1,000 and $5,000 in credit card debt with a personal loan netted borrowers an additional 17 points, on average, in a single billing cycle.
“While it may seem a bit like robbing Peter to pay Paul, taking out a personal loan to pay down credit card debt can be a savvy financial move that pays off in more ways than one,” the report stated.
Consolidating Debt Works to a Point, But It’s Not Fool Proof
Does Lending Tree have it right? Can credit card consolidation be a good option for struggling cardholders to tackle high-interest credit card debt?
Money management specialists generally agree, but there are caveats.
“A debt consolidation loan replaces your old debt with a new loan, possibly at a low-interest rate,” said Levon Galstyan, a Certified Public Accountant at Oak View Law Group, in Glendale, Cal. “If the new loan has a lower interest rate than your credit cards, consolidating your debt is a good decision. This can help you save money on interest, make your payments more reasonable, and minimize the time it takes to pay off your debt.”
When a consumer pays off credit card debt, the credit utilization rate becomes zero, and that helps to boost a credit score.
“You’re paying down the total amount, and that’s a good thing,” Galstyan said. “Prospective lenders are impressed. Plus, when you make monthly payments on the new loan on time, it helps to build a positive payment history. That helps to improve your credit score.”
In consolidating debt through a personal loan, however, consumers have to be ultra-diligent to make it work.
“When you’re taking out a personal loan to pay back debt, make sure that you're really making progress,” said Ted Rossman, senior industry analyst at Bankrate.com. “The credit bureaus have found that too many people were taking out personal loans to consolidate credit card debt but then running their card balances right back up.”
The best way to handle debt is to pay it off rather than worrying about consolidating, other financial experts say.
“The first step to get out of debt is to lock all of your credit cards and stop taking out debt,” said Jay Zigmont, a money manager and founder of Live, Learn, and Plan, a Mississippi-based financial advisory firm. “It’s very hard to pay off your debt while still taking out more.”
After curbing spending, set a specific goal for household debt reduction.
“For instance, commit to paying $6,000 in debt over the next year, and plan on making a payment each month in your budget (i.e. $500 per month),” Zigmont advised. “You can follow the "snowball method" (pay off the smallest debt first) or the "avalanche method" (paying off the highest interest first). But what really matters is that you keep paying off debt as a focus.”
