Where to Find Credit Card Debt Consolidation Help

Reader Question: I want to buy a home within the next couple of years (preferably next year), but I have several credit cards that are nearly maxed out. I was considering a debt consolidation plan of some kind to help out with this. Is this a good idea to help me get qualified for a mortgage loan late on? And where can I find credit card debt consolidation help that's legitimate?

You've actually touched on several important issues with your question, so let me address them one at a time.

Will debt consolidation of credit cards help me qualify for a mortgage loan?

It may or may not help, depending on your financial circumstances and the method of consolidation you use. So before I go any further in answering this question, let me state my usual disclaimer. I am not recommending for or against a credit card debt consolidation in your particular case -- that's obviously a decision you'll have to make on your own. The purpose of this blog is to help you gain some perspective on the issue, so you can eventually make a well-informed decision.

Okay. With that disclaimer out of the way, let's press on.

Yes, consolidating your credit card debt can be an effective financial move in general, and it can also help you qualify for a mortgage loan down the road. Most importantly, it can help you improve your life by (A) reducing the excessive accumulation of interest and (B) giving you a path to a debt-free life.

In order to understand how credit card debt consolidation ties into mortgage loan approval, I have to introduce some financial terminology. You may already be familiar with these, but for the benefit of other readers I must explain credit utilization ratio and debt-to-income ratio. Both of these things influence your chance of getting a home loan, and they are both directly related to your credit card debt.

• Credit Utilization Ratio -- Simply stated, this is the percentage of your available credit line that you are currently using. Let's say I have three credit cards, and each of them has a $10,000 limit. That means my total limit across the three cards is $30,000. If I add up all three of my balances (amount owed) and it comes to $15,000, then I'm using half of my available limit. Here, my credit utilization is 50%. And that's not so good! This is one of the primary factors that influence your credit score.
  
• Debt-to-income ratio -- This is another comparison expressed as a percentage, but it compares your monthly gross income to the amount of money you pay toward your debt each month. In other words, it shows how much of your take-home pay goes toward debt payments every month. Mortgage lenders will consider your DTI ratio (among other things) when considering you for a loan.
  

So what do these things have to do with a credit card debt consolidation and mortgage approval? Everything! While they don't show the full picture of your finances, these two ratios do offer a snapshot of how well you manage your finances, how much debt you carry, how much you are currently relying on credit, etc. In other words, they help lenders determine the level of risk associated with giving you money.

Now, let's talk about credit card debt consolidation and how it affects these two items (and your chances of getting a mortgage loan). There are actually several ways you can consolidate your debt, but I'm going to focus on what I feel is the best option in most cases. I'm going to discuss a debt consolidation loan and how it ties into all of this.

Credit card debt is one of the worst kinds of debt to have, especially when you have a lot of it. Based on your question, it sounds like you already know the reasons why. And it can be summed up with one word -- interest. Aside from "payday loans" and other cash-advance tools, credit cards generally have the highest interest rate of any form of debt. Higher than mortgages, car loans, student loans, etc. This is especially true if you've missed payments in the past, in which case the credit card company will usually jack up your interest rate.

Some people have so much credit card debt (with so much interest on top of it), that they'll be paying it off for the rest of their lives. Why? Because people in this situation are typically unable to pay more than the minimum balance due each month. You can never pay off your credit card debt my making only the minimum payment. The system is designed that way on purpose. From the perspective of the card companies, the best kind of customer is the one who has to make payments for his or her entire life! It's sort of like being a drug dealer ... you don't ever want your buyers to kick the habit. You want them for life.

This is the biggest problem with running up a lot of credit card bills. It can be extremely difficult to pay off, because of the interest that accumulates on top of the principal.

This is also where the credit card debt consolidation loan comes into the picture. It could save you a lot of money on interest, not to mention making your life a lot easier. Some people are paying a ridiculous amount of interest on their credit card balances, and when you spread that over multiple cards it becomes staggering. So the idea with a consolidation loan is to combine all of that high-interest debt and pay it off with a single loan -- ideally one with a lower interest rate.

For example, consider the amount of money you could save (and how much easier it would be to pay down your debt) if you replaced four credit cards with 20% interest rates with a single consolidation loan with a 10% interest rate. Suddenly, there is a light at the end of the tunnel.

Now let's revisit the concept of the credit utilization ratio we defined earlier. Let's say you have four credit cards. Three of them have big balances that are near the limits (if not maxed out already), while one of them has a smaller balance. If you use a credit card debt-consolidation loan to pay down the big balances on the three cards, you suddenly have a much more favorable credit utilization ratio ... because you are using much less of your available limit. And as you can see from the chart below, this ratio (expressed in red and labeled as "amounts owed") is a major influence on your overall credit score. Achieve a more favorable utilization ratio, and you could increase your credit score as well. In turn, this would make it easier to qualify for a mortgage loan.



Keep in mind, however, that you can pay down a balance without closing the account. And in some cases, this is the better option. You see, if you close your oldest credit accounts completely (like that card you got when your first turned 18), you would be shortening the length of your credit history in the process. This could affect your score in a negative way. You can see from the chart above that the length of your history is also a big factor in your overall score. So in some cases, it's best to keep an account open even if you pay the balance down to nothing -- or next to nothing.

When used properly, this strategy for credit card debt consolidation (and others like it) can also help you improve your debt-to-income ratio that we defined earlier. By cutting down all of that interest into something more manageable, you would have an easier time paying down the debt. This will give you a more favorable DTI ratio, which can improve your chances of getting qualified for a mortgage loan.

Let's move on to your second question.

Where can I find debt help that's legitimate?

By using the word "legitimate," you have suggested that you are somewhat suspicious of debt consolidation help and the companies that provide it. I can understand this concern. Unfortunately, we live in a world where some people see the misfortune of others as an opportunity for themselves. This is true of debt consolidation companies as well.

With that being said, however, there are many legitimate and reputable companies that can help you come up with a credit card debt-consolidation plan. Of course, this process all starts with you. You'll need to have the motivation and discipline needed to reduce your debt. But there's plenty of help to be found. Here are some companies and programs you might want to consider:

• Credit.com offers some free debt consultation programs. You might want to look into that and see if it appeals to you.
• The National Foundation for Credit Counseling is a non-profit organization that offers a variety of financial counseling to consumers. They have several debt-related counseling programs as well, and some of them are free.
• Bankrate.com has a good article that explains the pros and cons of the various debt consolidation methods. It's worth a read as well.
  

I hope that answers your question, and I wish you all the best in your financial future. Good luck, and happy holidays.

~Brandon