American credit card debt has reached an all-time high of $1 trillion, according to the Federal Reserve Bank of New York.  With so many Americans facing debt, now is the time to learn how to confidently navigate through your finances. The first step is creating a financial wellness plan that can help you meet your financial goals and manage your debt this year.

According to a recent Charles Schwab Corp. survey, only 28% of Americans have a written financial plan. Of the remaining 72% who don’t, half of those believe they don’t have enough money to make a plan worthwhile. The rest feel it’s too complicated and time-consuming to do so.

However, consider the fact that having a financial wellness plan in place has proven to build confidence, peace of mind and the ability to understand and achieve financial goals.

Starting your journey to financial wellness does not require a lot of savings. It starts with shaping your spending habits in ways that benefit your future self. A good place to start would be to set your budgeting percentages with the 50/30/20 method and link your bank account to a budgeting app that helps you track your habits. This approach gives you an idea of where your money is going, so you can make decisions that prioritize your goals.

Budget Percentages
Needs (50%)	Wants (30%)	Savings & Debt (20%)
●     Groceries ●     Housing ●     Utilities ●     Transportation	●     Shopping ●     Dining out ●     Hobbies ●     Leisure	●     Investments ●     Student loans ●     Credit Card

Having a financial plan in place can help you make better financial decisions and boost your confidence in the process. And, like any journey, it helps to have people along the way pointing you in the right direction.

Once you meet a certain goal, where to next? If something unexpected happens, what private or public programs exist to help you through it? Consider the help of a financial coach to guide you.

Creating a financial wellness plan with the help of a financial coach can be part of your first step forward to financial confidence. With a financial coach, you receive answers to your questions, guidance, and support as you work toward your financial goals.

Financial coaches can help you with debt management, so you can get out of debt and no longer be one of the many Americans with record-high debt.

 

You work hard to protect your identity. You’re cautious about sharing personal information, you regularly change your passwords, and you keep an eye on your credit report. But despite your diligence, there’s a form of identity theft that’s becoming increasingly prevalent and is notoriously difficult to detect — synthetic identity theft.

Understanding this growing threat can help protect your financial health and peace of mind. Here’s a comprehensive guide to help you grasp the ins and outs of synthetic identity theft so you can safeguard your future and that of your family.

What Is Synthetic Identity Theft?

Synthetic identity theft is an intricate form of financial fraud that blends stolen personal details with fabricated information to create a new, unique identity.

Unlike traditional identity theft where the criminal fully takes over someone’s identity, synthetic identity theft combines your real information, such as your Social Security number or date of birth, with other fake information to make it more difficult to trace.

The complexity of synthetic identity theft often allows it to go undetected for longer periods. By merging real and fabricated information, it becomes a monumental task to identify these fraudulent activities, often allowing criminals to continue to exploit the financial systems.

Their aim is to create a convincing identity that fools creditors, like banks and credit card companies, into extending loans and credit which are eventually defaulted on.

How Synthetic Identity Theft Works

1.   Gather Initial Information

The synthetic identity theft process begins with the acquisition of your personal details. Perpetrators may use various tactics such as phishing emails, which are designed to look like they come from trustworthy institutions, to lure you into revealing your data.

They can also hack into databases where your details might be stored — these can be databases of online retailers, healthcare providers, or even educational institutions. Some criminals might even resort to old-school methods like dumpster diving, where they scavenge for discarded documents that may contain your personal details.

2.   Craft the Synthetic Identity

After obtaining the necessary information, criminals enter the next phase which involves the careful blending of real and fake data.

This composite identity may use your Social Security number paired with a fictitious name, a different address, and even an altered date of birth. The aim here is to make this synthetic identity as realistic as possible while minimizing the risk of quick detection.

3.   Build Financial Credibility

Once the synthetic identity has been crafted, it’s time to give it financial life. Initially, criminals may apply for credit cards or smaller loans.

While these applications often get denied due to the lack of a credit history, they serve a hidden agenda: establishing a credit profile with credit bureaus. This initial interaction with the financial system is usually enough to create a thin credit file, helping give the synthetic identity some semblance of financial existence.

4.   Exploit Legitimate Accounts

With the credit profile set up, the fraudsters move to the next stage, “piggybacking.” This involves unauthorized association with existing, good-standing credit accounts.

They add the synthetic identity as an authorized user, thereby absorbing some of the primary account holder’s good credit attributes. This process can rapidly inflate the creditworthiness of the synthetic identity, helping make it appear more legitimate to creditors.

5.   Achieve the End Game

After successfully piggybacking and possibly obtaining small loans or credit lines, which they pay off diligently, the synthetic identity’s credit score begins to rise. Criminals may take this as a cue to aim higher, seeking out larger loans and more substantial lines of credit.

Once a significant credit limit is approved, they often max out the credit lines or withdraw large loan amounts, only to disappear, leaving the financial institution with losses and the real individuals whose details were stolen with a mess to clean up.

Synthetic vs. Traditional Identity Theft

The Intricacies of Synthetic Identity Theft

Synthetic identity theft involves a mix of real and made-up information, resulting in a new, distinct identity that can often bypass standard fraud detection measures. This makes it a long-term play for criminals.

The more they nurture this synthetic identity, the more complex and extensive the fraud can become. Because of the merged details, tracing these activities back to a single individual can become increasingly complicated, often allowing the criminals to evade capture for extended periods.

The Simplicity of Traditional Identity Theft

In contrast, traditional identity theft is typically relatively straightforward. Criminals steal an individual’s entire identity, often using it to make large purchases or withdraw funds as quickly as possible.

They aim to maximize their ill-gotten gains before the victim realizes what has happened and acts to stop further fraud. This immediacy often makes traditional identity theft easier to detect, but it can still be devastating for the victim.

Detecting Synthetic Identity Theft

Detecting synthetic identity theft can be challenging because the criminals are not merely hacking accounts but creating a façade of legitimate financial behavior. They typically nurture these fabricated identities by responsibly using the fraudulent account, making it appear as if a real person is just experiencing financial difficulties.

Children are particularly vulnerable targets for synthetic identity theft as they likely won’t be checking their credit reports for years, leaving ample time for criminals to exploit their Social Security numbers.

How to Help Protect Yourself Against Synthetic Identity Theft

Given its elusive nature and devastating impact, defending against synthetic identity theft often requires a more nuanced approach than traditional identity theft prevention. Here are some targeted strategies:

Protect your SSN

Your Social Security number is a golden ticket for fraudsters. In most cases, you should not carry your Social Security card with you. If you must disclose your SSN, make sure you’re in a private setting and try not to repeat it aloud within earshot of others.

Remember to discard documents containing your SSN carefully — shred them or black out the information.

Use Security Software

Deploy a multi-layered security software suite that provides comprehensive digital protection. Opt for a solution that offers real-time monitoring, identity theft insurance, and alerts for crimes committed in your name.

Understand Vulnerabilities

Knowledge is your first line of defense. Make it a point to understand the tactics fraudsters employ to steal your personal information. Once you know their tricks, you may be less likely to fall for them.

Monitor Your Credit

Regularly review your credit report for unauthorized activities. IdentityIQ identity and credit monitoring offers synthetic identity theft protection, alerting you to suspicious activities that could suggest your information is being used to create a synthetic identity

FAQs

What are the warning signs of synthetic identity theft?

Indicators of synthetic identity theft may include receiving unexpected bills, uninitiated credit inquiries, or accounts you did not open appearing on your credit report. You might also receive calls or letters from debt collectors about debts that aren’t yours.

Who’s most at risk of synthetic identity theft?

Anyone can fall victim to this form of identity theft, but certain groups are more vulnerable. This includes children, whose credit histories are clean slates, and the elderly, who may not be as digitally savvy. Others at high risk include individuals with limited or poor credit histories, military personnel, prison inmates, victims of data breaches, and those with high social activity or public records.

What can happen if you become a victim of synthetic identity theft?

• Financial Damage: Scammers can open accounts in your name, racking up debt and negatively impacting your credit score.
• Difficulty Borrowing: Your ability to secure loans and credit cards may diminish due to poor credit history.
• Emotional Distress: Dealing with the fallout of identity theft can be stressful and anxiety-inducing.

What is an example of synthetic identity theft?

• A thief steals a child’s unused Social Security number and creates a fake identity with a fictitious name and address. They use this identity to open credit cards and make purchases, leaving the child with a mountain of debt and a tarnished credit history.
• A criminal obtains deceased individuals’ personal information and combines it with fabricated details to create new identities for themselves or others. They then use these fabricated identities to apply for benefits, commit tax fraud, or even obtain employment.

What are some warning signs of synthetic identity theft?

• You receive credit reports or bills for accounts you never opened.
• You see sudden unexplained changes in your credit score.
• You are denied credit or loans for seemingly no reason.
• You receive collections notices for debts you don’t recognize.
• You see unfamiliar addresses or phone numbers listed on your credit report.

Key Takeaways and More Ways to Stay Protected

1. Secure Your Social Security Number: Do not share it or leave it open on computers, cell phones, or tablets.
2. Beware of Phishing Attempts: Be cautious of phishing attempts that may be aimed at tricking you into sharing your personal information.
3. Freeze Your Credit Reports: If you feel you are being targeted with a synthetic identity theft scam, freezing your credit reports can help protect you. This action can help stop potential scammers from opening accounts in your name.
4. Monitor Your Personal Information: Monitor your personal information with IdentityIQ identity theft protection services so you can be alerted if it falls into the wrong hands.
5. Opt-Out of People Search Sites: Remove your name from people finder sites to help keep your identity protected.

Bottom Line

Synthetic identity theft is an evolving and dangerous threat that can wreak havoc on your financial well-being and peace of mind. Taking proactive steps is more important than ever, and that’s where IdentityIQ services offer significant value.

The comprehensive platform not only provides credit monitoring in real-time, but also alerts you to threats to your personal information. The IdentityIQ robust suite of features are designed to help protect you and your family against various forms of identity theft.

Signing up for IdentityIQ is a quick, straightforward (and affordable!) process. If possible suspicious activity is detected once you’re under the protection of IdentityIQ, you are alerted in real-time, empowering you to act swiftly.

The holiday season is a time for joy, giving, and spending. However, it’s also a time when cybercriminals and scammers are highly active, looking to take advantage of the increased online shopping, financial transactions, travel, and frenzied holiday activities. That’s why it’s all the more essential to monitor your credit during the holidays.

Regular credit monitoring can help you protect your financial information, catch inaccurate credit reporting, secure the best holiday financing deals, avoid overspending, and enjoy peace of mind during the hectic holiday season. By keeping an eye on your credit, you can take proactive steps to safeguard your finances and ensure a stress-free and financially secure holiday experience.

Why Monitor Your Credit this Holiday Season?

The busyness and increased spending of the holiday season present a prime opportunity for cybercriminals and scammers to exploit the joyful celebration of others. With the right security efforts, you can help protect your personal information and finances. Here are the top-five reasons to monitor your credit this holiday season:

1.   Protect Against Fraud and Identity Theft

With the holiday season, it’s easy to let your guard down, making you a prime target for identity theft. Cybercriminals thrive on unsuspecting individuals and utilize various tactics, such as phishing scams, malware attacks, and skimming devices, to gain access to personal information, including credit card numbers, Social Security numbers, and other sensitive data.

Monitoring your credit offers a crucial layer of proactive protection to help against identity theft during the holidays. Credit monitoring and alerts can detect unauthorized activity, such as new credit accounts opened in your name or unfamiliar transactions on your existing accounts, and alert you to them in real time. This early detection helps eliminate potential threats before they have the opportunity to do even more damage. Real-time credit monitoring alerts empower you to take immediate action to help prevent further damage and mitigate risks to your financial well-being.

2.   Enjoy Better Peace of Mind During the Holidays

As the holiday season approaches, the pressure of gift-giving, pricey celebration events, and holiday budgeting can weigh heavily on your mind. Amidst the holiday festivities, it’s easy for financial worries to creep in, especially if you’re concerned about your creditworthiness. However, regular credit monitoring can help alleviate these concerns and provide much-needed peace of mind during this hectic period.

With credit monitoring and alerts, you can celebrate in peace, knowing your finances are protected. Keeping tabs on your credit also helps you gain a clear picture of your financial standing, allowing you to make informed decisions about holiday spending.

You can avoid overextending yourself by understanding your credit limits and credit utilization ratio, ensuring you don’t take on more debt than you can manage. Additionally, monitoring your credit can help you identify any potential issues that can impact your ability to secure favorable financing terms for holiday purchases.

3.   Catch Credit Report Inaccuracies

Unfortunately, credit reports are not immune to inaccuracies. If it does happen, even the most minor inaccuracy on your credit report can damage your financial well-being. Inaccurate credit reports can lead to denied loan applications, higher interest rates, and even job rejections in certain states.

Regular credit monitoring can help you catch these inaccuracies before they cause significant harm. By scrutinizing your credit report regularly, you can identify any discrepancies, such as incorrect account listings, outdated information, or inaccurate credit inquiries. Once you detect an inaccuracy, you can file a dispute with the credit bureau to correct it.

4.   Secure the Best Holiday Financing Deals

The holiday season delivers a surge in spending as individuals take advantage of special deals and promotions to purchase gifts and enjoy festive activities. However, this increased spending can also lead to financial strain, especially if you rely on credit cards or other financing options to cover your expenses.

If you are financing your holiday purchases, securing the best holiday financing deals is vital for managing your holiday spending responsibly and avoiding excessive debt. Your credit score plays a significant role in determining the interest rates and terms you can receive on loans, credit cards, and other financing options. A higher credit score indicates lower risk to lenders and can make you eligible for more favorable terms and lower interest rates.

Regular credit monitoring can help you identify any areas where your credit score might need improvement. By tracking your credit utilization ratio, payment history, and other credit factors, you can make informed decisions to enhance your credit standing and position yourself for the best possible financing deals during the holidays.

5.   Avoid Overspending

The allure of holiday shopping can be overwhelming, with tempting deals, festive promotions, and the desire to spoil loved ones. However, overindulging in spending during the holidays can quickly lead to financial strain and post-holiday regrets. Regular credit monitoring can serve as a valuable tool to help you avoid overextending yourself financially.

By keeping a close eye on your credit usage, you can maintain awareness of your overall financial picture and make informed decisions about holiday spending. Regularly checking your credit balance and credit utilization ratio can help you stay within your budget and avoid exceeding your credit limits. Additionally, credit monitoring can alert you to any unauthorized transactions, preventing fraudulent charges from inflating your holiday spending.

Bottom Line

As the holiday season approaches, it’s crucial to prioritize your financial well-being amidst the festivities. By regularly monitoring your credit, you can safeguard your financial information, catch inaccuracies, secure favorable financing deals, avoid overspending, and enjoy peace of mind throughout this busy season.

IdentityIQ comprehensive credit monitoring services provide real-time alerts, detailed reports, and personalized recommendations, empowering you to make informed financial decisions and protect your financial health. IdentityIQ helps ensure financial stability and peace of mind while you enjoy the fun of the holiday season.

Remember, your credit is a valuable asset that deserves your attention. By prioritizing credit monitoring, you can safeguard your financial future and enjoy the holidays in peace.

Credit card locks and credit freezes are security features that can be used to help protect you from fraud and identity theft. But even though they sound similar, they perform very different functions when keeping you safe.

The key difference: credit card locks help protect your credit card from fraud, while credit freezes help protect your credit report from identity theft. It’s important to understand how both work so you know the best way to protect yourself.

What Is a Credit Card Lock?

Credit card locks offer a way to “turn off” your card so it can’t be used by anyone. The idea is that if you misplace a card, you can lock it to prevent fraudulent charges until you are able to locate it.

When you find your card, you can unlock it without having to contact your card issuer.

While you generally aren’t liable for fraudulent credit card charges, locking a card can help reduce hassle later by removing the need to report unauthorized transactions. And if you misplaced a card and you’re likely to find it later, you can avoid having to replace your card and updating your payment information for all your accounts.

When you lock your card, new transactions and cash advances won’t go through. But recurring autopayments, such as subscriptions and monthly bills, will continue to be charged to your account. Fees, returns, credits, and interest will also function as normal.

How to Lock Your Credit Card

To initiate a lock or unlock your card, you need to use your card issuer’s mobile app or log in to your online account.

When Should You Lock Your Credit Card?

You should lock your card when it’s misplaced to ensure no one can use it while you look for it. This can help you avoid replacing your card if you believe you’ll find it soon. You may also want to lock a card that you still have but rarely use, or when you’re going on vacation someplace where you can’t use your card for a while. You could even prevent a secondary cardholder (or yourself) from making purchases.

Remember, locking a credit card is not an effective replacement for reporting it lost or stolen. If you truly can’t find your card or you believe it was stolen, you need to report your card missing to your card issuer and get a replacement card as soon as possible. In addition, you should check your credit card statement and report unauthorized transactions to the credit card company. This is a more permanent solution to help protect your account.

Can I Still Use a Locked Credit Card?

Locked credit cards continue to automatically process recurring autopayments. To use your credit card for everyday purchases, you need to unlock the credit card first.

Which Issuers Offer Credit Card Locks?

Many credit card issuers offer credit card locks, including American Express, Capital One, Chase, Citi, Discover, and Wells Fargo. When shopping around for a new credit card, make sure to review the available security features.

Is a Credit Card Lock the Same as a Credit Freeze?

No. A credit card lock is a security feature that prevents use of your credit card. With a credit freeze, you prevent unauthorized parties from viewing your credit report.

What Is a Credit Freeze?

Credit freezes block access to your credit report so lenders and other companies cannot view it until you lift the freeze. If someone obtains your information and tries to open a line of credit or loan in your name, the creditor processing the application is unable to view your credit file and then rejects the application. It is an additional layer of security that helps prevent unauthorized access to your credit report, effectively stopping common forms of identity theft.

It is federally mandated that credit freezes be free for all American consumers. This decision was made to combat the rising levels of fraud and identity theft over recent years.

How to Freeze Your Credit

To freeze your credit file with all three major credit bureaus – Equifax^®, Experian^® and TransUnion^® – you must contact each one individually and make the request online, by phone or by mail. It’s important to do this for every single credit bureau so that all your credit reports are protected.

You need to verify your personal information to prove your identity, including:

• Full name
• Date of birth
• Social Security number
• Address

Once you’ve proven your identity and put the freeze in place, your credit file is not available to lenders unless you lift the freeze. You receive a PIN that allows you to temporarily or permanently lift the freeze to open new credit accounts as needed.

When Should You Freeze Your Credit?

A credit freeze is a highly effective way of protecting your credit file from fraud. If you believe you are the victim of identity theft, you should immediately freeze your credit with all three credit bureaus to prevent further fraud from occurring.

But you don’t have to wait to become a victim to freeze your credit – anyone can freeze their credit reports at any time to proactively prevent fraud. If you do this, you just need to unfreeze your credit report whenever you submit a legitimate application for credit.

Bottom Line

Credit card locks and credit card freezes are valuable tools in the fight against credit card fraud and identity theft. But IdentityIQ identity theft protection takes it one step further, monitoring your identity for signs of fraud and warning you when changes land on your credit report.

FAQs

Do card locks work for debit cards, too?

Yes, many banks allow you to lock your debit card.

Are there still times you should cancel your card?

Yes. If you know your card is stolen or has been permanently lost, you should immediately cancel your card and order a replacement to help protect your account.

Does locking a credit card affect your credit score?

No, locking your credit card does not affect your credit score.

Does freezing your credit affect your credit score?

Freezing your credit does not directly impact your credit score. It may prevent fraudulent activity from appearing on your credit report, which helps protect your credit score from the negative effects of identity theft.

Having a good credit report is important if you want to take out loans, apply for a mortgage, or get low interest rates. Your credit score is determined by major credit bureaus, including Experian®, TransUnion®, and Equifax®, and they independently set your credit score based on information they receive from your lenders.

If you have a bad credit report, due to late or missed payments on loans and debts, it can lead to higher interest rates on mortgages, personal loans, credit cards, and other types of loans. However, because it is unfair to punish people forever because of financial mistakes from long ago, most forms of bad credit fall off your credit report after seven years.

If you’re curious about the seven-year rule as it relates to your credit report, you’ve come to the right place. This article delves into how this rule works, what happens to unpaid debt after seven years, and more. We also look at how to rebuild and monitor your credit and why a positive credit report has major financial advantages.

The 7-Year Rule: What It Means

As we briefly touched on, the seven-year rule refers to the fact that negative items on your credit report will disappear after seven years. You acquire negative information by failing to make monthly payments on credit card debt, student loans, your mortgage, and other types of loans. Other types of negative information include late payments, charge-off accounts, bankruptcies, and more.

Failing to make these payments “discredits” you, leading to a bad credit report because you have a poor track record of paying your debts. When this happens, lenders are more reluctant to loan you money in the future and will charge higher interest rates because of the risks involved.

When Does the 7-Year Period Begin For Negative Items?

Generally speaking, the clock starts ticking for negative items on your credit report immediately after your first missed payment. For instance, let’s say you missed a payment for your credit card in February 2022.

Your credit report will reflect that fact, and your credit score may suffer until February of 2029. At that point, it can essentially be written off of your credit report, even if you continue to miss payments after February 2022.

However, it’s important to note that just because the bad credit falls off your report doesn’t mean the debt is erased. It simply won’t hurt your credit report anymore. You will still owe whatever amount you originally did, plus interest.

Positive Information and Its Duration on Credit Reports

While negative items on your credit report disappear after seven years, positive information stays on your report indefinitely! Positive information includes things like on-time payments, maintaining a good credit utilization ratio, having a positive account history, and more.

The only time that positive information doesn’t stay on your credit report permanently is if you close an account. In that case, positive information typically gets removed from your report 10 years from the time you close the account.

Benefits of a Good Credit Report

In addition to showing responsibility and maturity, having a good credit report positively impacts your finances. You’ll be able to take out loans at lower interest rates than before, leading to less interest and lower monthly payments. You will also have higher credit limits on credit cards and better insurance rates. For these reasons, it’s essential to maintain positive financial behaviors so that you can keep a low credit score.

Additionally, because bad information can disappear from your credit report after seven years, it’s never too late to turn your finances around and improve your score.

Removing Negative Information After Seven Years

The good news about negative information on credit reports is that it typically gets deleted automatically after seven years. You most likely won’t have to call your bank, lender, or credit union and ask them to delete it.

What to Do If Negative Information Isn’t Automatically Deleted

If, however, for some reason, bad info doesn’t automatically fall off your credit report after seven years, here are your options to remedy the problem.

1. File a dispute with the credit bureau reporting your credit – Experian, TransUnion, or Equifax.
2. If that doesn’t work, file a dispute directly with your creditor — the bank, credit card company, or agency who lent you money and recorded your failures to the credit report agency.

Once those negative items are removed from your credit report, you should see your score start rising. This can increase the amount of borrowing options you have and the terms that lenders offer. Therefore, it’s important to be persistent in getting items removed from your credit report if you believe they have surpassed the seven-year statute of limitations.

Rebuilding Credit Post 7 Years

Just because negative info, such as a late payment, a past due balance, or unpaid credit card debt, falls off your credit report, that doesn’t mean it will instantly improve. Instead, you will need to work hard and take initiative to rebuild and improve your credit score. Here are a few great ways to get started.

• Regularly review and actively monitor your credit report to make sure it’s in good standing.
• Pay your monthly bills on time for housing, car leases, student loans, and other loans.
• Pay off credit card debt as quickly as possible.
• Keep your credit utilization ratio below 30%.
• Avoid hard credit inquiries when possible.
• Diversify your credit mix.
• Use credit report monitoring that includes a simulator for actions you can take, such as paying off a credit card, and how those actions can affect your credit score.

You can also consider applying for a secured credit card or credit-builder loan. These types of loans and cards require a small deposit on your part, making them more accessible for people who have bad credit and are trying to rebuild it. By making your monthly payments on these, you’ll soon qualify for other forms of credit cards and loans.

Exceptions to the 7-Year Rule

While seven years is the statute of limitations for when most debt expires, there are exceptions to the rule.

Hard Credit Inquiries

Hard inquiries into your credit, for example, typically fall off your credit report after just two years.

Unpaid Federal Tax Liens

On the longer end of the spectrum, unpaid federal taxes leading to tax liens can stay on your credit report for up to fifteen years or more. Paid tax liens, however, only last for seven years.

Chapter 7 Bankruptcy

Finally, Chapter 7 bankruptcies can stay on your credit report for up to ten years, as opposed to Chapter 13 bankruptcies, which only stay on your credit for seven years.

It’s important to understand if you have any of these outstanding debts or liens because it will affect how long it takes for bad info to fall off your report and how soon you can start rebuilding your credit.

Monitoring Your Credit Report

If you’re serious about keeping a good credit score, it’s important to monitor your credit report closely. If you review your credit report and notice that something doesn’t look right, it’s important to file a dispute with your credit bureau or creditor as quickly as possible. Swift action is the best way to get inaccuracies removed from your credit report.

Bottom Line

If you currently have bad credit because of past mistakes, don’t worry — it won’t last forever. Once they reach the seven-year mark, most bad credit items should fall off your credit report. When that happens, it’s important to take action to rebuild your credit by making wise financial decisions, paying your debts on time, and closely monitoring your credit report. To stay on track, use IdentityIQ credit monitoring services for 24/7 monitoring with real-time notifications of significant score changes and a score simulator.

Personal debt in the United States is at an all-time high, leading many Americans to look for creative ways to eliminate it. According to The Motley Fool, the average American has just over $100,000 in debt, split between personal loans, mortgages, credit card debt, student loans, and more.

Because of the high interest rates that often get tacked on top of loans, many people consider taking out a debt consolidation loan to pay off their debts. If you’re considering going this route and want to know if it’s the right option for you, keep reading!

What is Debt Consolidation?

As the name implies, debt consolidation is when you merge all your debts into a single payment. You can do this with a debt consolidation loan, which you can get as a personal loan from your bank, online lenders, credit unions, and others.

The goal of debt consolidation is to make it easier and more manageable to pay off your debt by condensing it into a single payment. However, because of how these types of loans work, they might not always the best option for everyone.

How Does Debt Consolidation Work?

There are two basic ways that a debt consolidation loan can work. First, you can go to a lender and give them detailed information about who you owe money to and how much. The lender can then pay each party what you owe them, and you’ll have to pay back the lender for the total cost of your loan plus interest.

The other option is to take a lump sum loan from a lender and pay back each of your creditors on your own. Next, you’ll make monthly payments to the lender who gave you the consolidation loan until it’s paid in full.

Essentially, you’re trading one form of debt for another. However, debt consolidation can make the repayment process easier because you only have to worry about one loan and interest rate.

Pros and Cons of Debt Consolidation

The Pros of Debt Consolidation

Streamlines Finances

The main reason that people take out debt consolidation loans is that it can help make it easier to manage your loan payments and interest rates. Rather than worrying about credit card debt, student loan payments, car payments, and many others, you have a single monthly charge.

May Expedite Payoff

If you can find a debt consolidation loan with reasonably low interest rates, you can pay off your total debt faster. You can do this by taking the money you save on high-interest debts and applying it as extra towards your consolidation loan.

Could Lower Your Interest Rate

Debt consolidation loans often have a lower interest rate than credit card and car loan payments.

 May Reduce Monthly Payment

Finally, depending on your lender and the size of your debts, a consolidation loan might have a lower monthly payment.

The Cons of Debt Consolidation

You May Pay More in Interest Over Time

On the downside, debt consolidation loans can typically result in a higher overall payment. As such, paying it off usually takes longer, resulting in paying more total interest.

You Risk Missing Payments

As with any loan, if you miss a payment or two on a debt consolidation loan, your credit score can take a hit, and you might incur unwanted penalties.

May Come with Added Costs

Another downside of consolidating debt is that you may have to pay unwanted fees on your new loan, plus closing costs on your old ones.

Doesn’t Solve Underlying Financial Issues

It’s important to note that consolidating your debt won’t necessarily solve the money management and spending problems that got you into debt in the first place. You will still need to learn to manage your money to avoid massive debts in the future. A financial coach can help provide you with guidance when it comes to managing your debt.

Could Raise Your Interest Rate

While a debt consolidation loan could potentially lower your interest rate, it could just as easily result in a higher one.

May Encourage Increased Spending

Finally, when you consolidate your loans, you might be tempted to think you have less debt than before. If you lack discipline, this can lead to increased spending and more debt.

When to Think Twice About Debt Consolidation

As you can see, knowing if debt consolidation is right for you is tough. To simplify things, here’s a list of red flags to help indicate when debt consolidation is a bad idea.

• Your new monthly payment is higher than the old ones.
• You’re within a year of paying off your current debts.
• Opening a new credit account is more trouble than it’s worth.
• Your low credit score doesn’t allow for better terms than what you currently have.
• You don’t currently have a job or are thinking about seeking new employment.
• The fees involved in debt consolidation are too high.

Factors to Consider Before Consolidating Your Debt

Here are a few additional things to consider before consolidating your debt.

The Setup Fee

One of the most significant downsides of a debt consolidation loan is that you’ll typically have to pay a startup fee. On average, lenders charge anywhere from 1% to 5% of the total loan as the startup fee. Debt consolidation is not a good option if this is more than you can afford.

The Monthly Fee

If the monthly payment on your debt consolidation loan is lower than the total monthly payments of your old debts, debt consolidation may be a good option.

The Package

Finally, it’s essential to consider the debt consolidation package as a whole. If there are minimal fees, a low setup cost, and a lower overall interest rate and monthly payment, you should consider debt consolidation.

Is Debt Consolidation a Good Idea?

Debt consolidation is a good idea if you’re having trouble keeping track of your monthly payments and think you’re overpaying. However, you should take the time to compare multiple lenders and loan options. If you end up with a higher interest rate, monthly payments, or overall payment, debt consolidation is not a good idea.

How Debt Consolidation Affects Your Credit Score

Because debt consolidation means taking out a large loan to pay off multiple smaller ones, your credit score will likely see a small dip. However, this dip is usually less than 10 points, and your credit score can bounce back within a year as long as you make your payments on time.

If you miss payments, however, your credit score will dip lower, and the information will stay on your credit report for up to 10 years.

Here’s a closer look at how exactly a debt consolidation loan can affect your credit score.

Hard Credit Inquiry

During a hard credit inquiry, a lender pulls your credit report to determine whether or not they want to lend you money. These are typically performed to determine if you are trustworthy in repaying your debts.

Unfortunately, hard credit inquiries tend to hurt your credit score ever so slightly. Therefore, the more hard credit inquiries you have, the lower your credit score can dip.

Credit Utilization

The second aspect of your credit score is your credit utilization ratio. This refers to how much credit you use versus how much is available. You can calculate it by dividing your total balances by your credit limit. Understanding your credit utilization ratio is important because lenders will use it to determine your debt management ability.

Payment History

Finally, the most important factor in determining whether or not a debt consolidation loan hurts your credit score is your payment history. If you have a reputation for making your payments on time and in full, your credit score likely won’t take a hit. On the other hand, expect a dip in your credit if you have a history of late payments.

When Debt Consolidation Isn’t Worth It

Because of the risks involved in debt consolidation, it isn’t always worth the cost or hassle. For instance, if you won’t be able to make monthly payments on your new loan, debt consolidation is a bad idea. Instead, focus on paying back loans with the highest interest rate and use whatever money is left to pay other debts.

Additionally, if you’re close to paying off your current debts and the interest rate on the consolidation loan is higher than the rates on your current loans, debt consolidation isn’t worth it.

Remember, debt consolidation isn’t a cure-all for your money problems and isn’t the right solution for everyone.

Frequently Asked Questions (FAQs)

Does consolidation hurt your credit?

In general, debt consolidation loans may hurt credit scores ever so slightly. In most cases, however, the damage to your credit score is minimal and barely noticeable.

When is debt consolidation not a good idea?

If you plan to pay off your debt within a year, have very manageable interest rates, or won’t be able to afford the new monthly payments, debt consolidation is not a good idea. The last thing you want is a debt consolidation loan that increases your debt amount or interest rate.

What is debt consolidation vs. a settlement?

Debt consolidation and debt settlement are two very different things. With debt consolidation, you merge all your existing debts into a single payment, but the result is that you pay each one in full. With debt settlement, you barter with each of your lenders in the hopes of having your debts reduced.

How long does debt consolidation stay on your record?

On average, debt consolidation loans can appear on your credit report for seven to ten years. In most cases, however, if you make monthly on-time payments in full, your credit score will bounce back within one year, and your debt consolidation will appear as a good thing on your credit report.

Will a consolidation loan affect me getting a mortgage?

In most cases, debt consolidation won’t affect your ability to get a mortgage. However, your credit score can take a hit if you fail to make your payments or require frequent hard credit inquiries. If it dips too low, it can affect your chances of getting a mortgage.

Bottom Line

As you can see, debt consolidation loans are a lifesaver for some people but can be a mistake for others. It all depends on whether or not consolidating your debt will result in lower interest rates, a lower overall payment, or more manageable monthly payments. If it doesn’t, and you’ll save money paying off your debts as-is, steer clear of debt consolidation.

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Whether it’s personal loans, student loans, car payments, or credit card debt, people owe more money today than they ever have. If you’re one of the millions of people struggling to pay back loans and debts, you’ve come to the right place.

This article explores two of the most common methods of debt repayment — the debt avalanche and the debt snowball. We help you decide which debt repayment plan is right for you and how to get on the road to financial freedom.

What is the Debt Snowball Method?

The debt snowball method is one of the most popular and practical ways to pay off debt. It was first popularized by Dave Ramsey, an expert in the world of personal finances and debt repayment. You can apply this method to all your debts, with the exception of your mortgage, as it’s in a class of its own.

The premise of the debt snowball method is that you start by paying off debts that are small and manageable. This means starting with the smallest debt on your record and putting most of your money toward paying it off. While doing this, you’ll make minimum payments on your other debts so as not to accrue additional penalties.

Once your smallest balance is paid off, you move on to the next smallest debt. In addition to the minimum payments you were already making, you take the funds you had allocated for the smallest debt and apply it to the next smallest one as well. You continue using this method, paying off one debt after another until you are debt free.

How the Debt Snowball Method Works

The key to using the debt snowball method is to focus on small victories that accumulate and get bigger over time, similar to a snowball. By starting with your smallest debt and getting it out of the way, you can create momentum toward reaching your end goal — paying off all your debts.

However, the only way that the debt snowball method will work is if you continue to make minimum payments on your larger debts as you pay off your smallest one. Otherwise, you’ll fall behind, get overwhelmed, and your debt cycle will continue.

Here are some suggestions that can help get you started with the snowball method.

Continue to Make On-Time Payments

Because all debts have penalties for late payments, it’s essential to make payments on time on all your debts.

Make a List of Debts

Next, make a list of your debts and their amount, and put them in order from least to greatest.

Focus on Paying Off the Smallest Debt

Start paying off small debts first, beginning with the smallest and proceeding to the largest.

Repeat Until Completed

As you eliminate each debt, cross it off the list and repeat the process until you’re debt-free.

Pros and Cons of the Snowball Method

Pros

Quick Wins

The biggest advantage of the snowball method is that you’ll receive instant gratification through quick wins. These wins are important for building motivation and momentum as you proceed to larger debts.

Helps Build Momentum

As you pay off one debt after another, you’ll build momentum that propels you forward in your quest to be debt-free.

Improve Money-Management Skills

In addition to paying off more debt than you ever thought possible, the snowball method teaches you important money and debt management skills to use in the future.

Cons

Ignore Interest Costs

The biggest downside of the snowball method is that it ignores interest rates and prioritizes small debts first. As a result, you may end up paying more interest because you’re only making the minimum payment on high-interest debt.

Wipes Out Cash Reserves

Because you’re putting all your extra income toward paying off your debt, you may wipe out your cash reserves and savings.

Extended Repayment Period

It may take longer to get out of debt using the snowball method because of the additional interest you will accrue.

What is the Debt Avalanche Method?

The second popular debt repayment plan is to use the debt avalanche method. Rather than starting with the smallest balance, the debt avalanche method starts with the debt that has the highest interest rate.

Using the debt avalanche method, you would likely start with your credit card balance because it will usually be a higher-interest debt. After that, you would tackle each proceeding debt in order of interest rate until all your debts are paid off. While this method offers the allure of paying the least amount of interest, it doesn’t always save people money.

How Does the Debt Avalanche Work?

Because the debt avalanche method can be more complicated than the snowball method, let’s look at a practical, real-life example of how it works.

Debt Avalanche Example

Let’s say that you have accrued the following debts.

• $10,000 credit card debt at an 18.99% annual percentage rate (APR)
• $9,000 car loan at 3.00% interest rate
• $15,000 student loan at 4.50% interest rate

Now, let’s imagine that you have $3,000 in extra money each month to put toward repaying your debts. Starting with the highest interest debt, you would first pay off your credit card balance. By putting every cent of the extra $3,000 towards the debt, you could have it paid off in 11 months, having paid $1,011.60 in total interest.

Next, you would proceed to your student loans, which have the second-highest interest rate, and so on. If you used the debt snowball method instead, you would first pay off the car loans since it’s the smallest balance and finish with your student loans.

Debt Avalanche Pros and Cons

The biggest advantage of the debt avalanche repayment method is that it reduces the total amount of interest you will pay when all your debts are resolved, which could save you money.

The downside, however, is that it requires more discipline than the snowball method, and you won’t see instant results. It will also take longer to pay off each individual debt, which could cause you to lose motivation and stop the strategy before you’re debt free.

Debt Snowball Vs. Debt Avalanche: Which is Better?

While both the snowball and avalanche methods focus on paying off debt as quickly as possible, they go about it in different ways. Depending on your financial situation, the snowball method might be preferable, even though you risk accruing more interest. The momentum you pick up from tiny victories is enough to motivate most people to get out of debt as quickly as possible.

The avalanche method, on the other hand, focuses on paying less interest by eliminating debts with high interest rates first. While this could save you money in the end, sticking to this plan is tough and takes a ton of discipline because you won’t see instant results.

Regardless of which method you choose, it’s essential to continue making minimum payments on your other debts so you don’t fall behind on them.

Cost of Debt Snowball vs. Debt Avalanche Method

To help you determine which repayment method is right for you, let’s look at the overall cost of using the debt avalanche method versus the debt snowball. Let’s say you have the following debts.

• A $10,000 loan balance with a 15% interest rate and $225 minimum monthly payments.
• A $5,000 loan balance with an 8% interest rate and $85 minimum monthly payments.
• A $1,000 loan balance with a 4% interest rate and $20 minimum monthly payments.

Using the snowball method, you would be out of debt in 38 months, having paid a total of $19,621. Using the avalanche method, you would be out of debt at a similar time and would have paid slightly less interest. However, there’s a higher likelihood that you wouldn’t have stuck with your repayment plan using the avalanche method because it takes longer to see initial results.

Which Method is Faster and Cheaper?

Sticking with the example above, you could pay off your debts in roughly the same amount of time. However, you would pay off your first debt in six months or less using the snowball method, whereas it would take over a year with the avalanche method because you’re starting with the highest interest rate debt.

Therefore, if small, quick victories will motivate you to pay off your debt faster, the snowball method is better. However, if you want to eliminate high interest debt first and potentially pay less in the long run, the avalanche method is preferable.

Which Debt Payoff Method is Right For You?

Ultimately, the method you choose to repay your debts depends on your personal circumstances and your personal preference. If your goal is to get out of debt while paying the least amount of interest possible, the avalanche method is right for you. Be advised, however, that this method takes more discipline and determination because you won’t see results as quickly.

If you need small victories to gain traction, the snowball method is the better option. There’s also a chance that the snowball method will save you money in the end, even though you risk accruing more interest.

Many people become more motivated as they see debts erased from their accounts and end up putting even more money toward their debts. As a result, they end up paying it off faster and with less interest than with the avalanche method. It’s also easier to stay on track with the snowball method, which could result in additional savings.

Alternatives to the Debt Snowball vs. Debt Avalanche

While the debt snowball and avalanche methods are two of the most effective ways to get out of debt, they aren’t the only ones. You can also opt to take out a debt consolidation loan, which is where you compile most, or all, of your existing debt into a single lump sum.

Because you’re focusing on paying off a single debt rather than three, four, or even more, some people have success with the debt consolidation method. However, debt consolidation can result in a higher interest rate and higher monthly payments, leading to a longer repayment period.

Debt consolidation loans also have additional risk, depending on who your lender is. You could potentially fall for a scam when you sign up for a debt consolidation loan if you don’t do enough research. Debt consolidation lenders may also be more aggressive than other lenders, leading to unwanted calls and harassment.

It’s essential to use a reputable organization such as Credit & Debt for guidance when it comes to debt consolidation. Credit & Debt provides financial coaches who can help guide you in making the right decision for debt management.

FAQs

What Are the Three Biggest Strategies for Paying Down Debt?

In addition to the debt avalanche and snowball methods, debt consolidation is the third main strategy for paying off debt.

How Can I Pay Off $50,000 in Debt in One Year?

To pay off $50,000 in debt in one year, you will need to be disciplined and motivated. You will also need to dedicate as much money as possible toward your debt and eliminate most non-essential expenses.

Did Dave Ramsey Invent the Debt Snowball Method?

Dave Ramsey invented the debt snowball method as part of his finance class at Financial Peace University.

Bottom Line

Whether you prefer the debt avalanche or debt snowball method, the ultimate goal should be to get out of debt as quickly as possible. You should utilize whichever method works best for you to achieve this outcome so that you can experience a life free of debt.

To make sure you’re staying on track, use IdentityIQ credit monitoring services for 24/7 monitoring with real-time notifications.