What is a Credit card
Before we begin, let us first start with the basics, which is what a credit card is. So what is a credit card?
A credit card is simply a card issued by a financial institution, usually a bank to her customers allowing such customers to purchase goods and services on credit (ie without actually paying for them with the customer’s own money). It is a kind of lending service by the bank and interest is collected on amounts borrowed by the customers.
Credit card interest is compounded. It could be monthly, yearly or even daily. Compounding is when new interests are paid on previous interests and principal. Take for example, you have a credit card debt of $5000 and it accrues 10% interest; then the first month you would be charged $500 (5000 x 0.10). For the second month the $500 for the previous month is added to the principal which makes it $5500. Then interest for the second month is calculated on the new principal derived = (5500 x 0.10)= $550.
The total debt for the two months would then be $5500 + $550 = $6050. So from $5000 to $6050 within two months. This is how quick the debt begins to add up until it becomes unbearable.
Credit Card debt consolidation
A credit card debt consolidation involves combining credit card balances onto a single card. This is because holding several credit cards bring about paying several monthly bills; each with a different interest rate which is often high. Credit card debt consolidation is sometimes referred to also balance transfer because it involves transferring balances from one credit card to another.
Another way to consolidate credit card debt is to borrow money from a financial institution (usually a bank) with a much lower interest rate then the credit card debt interest rate, then pay off the credit card debt with the new loan and settle the new loan in installments at a much lower interest rate.
Credit card debt consolidation / balance transfers can impact on your credit score. This is because consolidating credit cards and leveraging low balance transfer offers has the potential to increase your credit score although in a balance transfer you are more likely to incur a balance transfer fee which is an upfront cost for shifting your debt onto a new card.
The increase in credit score is achieved by a reduction in the credit utilization ratio. What is credit utilization ratio? A credit utilization ratio is the amount of credit you are using divided by the amount of credit available for use. 30% of the FICO credit score is determined by the credit utilization ratio of an individual. An individual can see a boost in his credit score by maintaining a credit utilization ratio of less than 30% at all times.
Balance transfers can then help credit utilization ratio because lower interest rates are paid during the introductory period which means that more debt can be paid off during this period. This thereby helps to reduce the credit utilization ratio. It is advised that you analyze the agreement diligently when seeking a credit card debt consolidation. A lot of credit card suppliers and banks advertise a 0% APR (Annual percentage rate), but this does not mean it is free. The 0% APR is usually for a period of time which may be between 6 – 12 months. Going into an agreement of credit card debt consolidation would then be more profitable for individuals who know that they can pay back a considerable amount of the debt within that period of 0% APR.
Even after transferring balances in credit card debt consolidation, it is advisable to leave the other accounts open because closing credit accounts can negatively affect your credit, but by keeping existing accounts open your average account age remains high and account age contributes to 15% of a credit score.
Remember that your goal should be to reach a level where you don’t carry debt on your credit card. This is because credit cards are not good long term loans and the monthly or daily compounding of interest is not be best for you.
Legal Disclaimer: The article provided herein is for informational purposes only and is not intended as a substitute for professional advice.