June 16, 2014 at 1:00 am

Debt adviser

Debt consolidation won't fix spending ills

Q: I have about $50,000 of debt on credit cards. My credit rating is still high. I am considering a debt consolidation loan. Will that adversely affect my credit rating?

A: The cliche about rearranging the deck chairs on the Titanic came to mind when I read your question. Debt consolidation wonít address the real issues that may sink your credit rating!

Moving the balances of your credit card accounts into an installment loan for purposes of consolidation may cause a slight dip in your credit score. The main reason is you will have a new inquiry and huge installment loan show up on your credit report, even though you also will have much lower debt-to-credit ratios on your credit cards. The potential underwriting risk that you present to a new lender is measured in conjunction with your credit score and will now have to incorporate that you have the opportunity to begin adding to your credit card balances again. And the fact that many people do just that is why the action will temporarily bring down your rating.

For the record, and for those who donít know the difference, a credit rating and a credit score are two different things. A credit score is derived from items reported in your credit file. It uses a complex mathematical algorithm to come up with a score that predicts whether you are more or less likely to default on your next loan. A credit rating is assigned by a person who looks at issues beyond your credit report before determining how creditworthy you are. These issues include income, job stability, your ability to use dormant credit lines and more.

I want you to concentrate on your overall financial health rather than on a score or rating. If your financial health is strong, the measures will reflect it. The real questions to be answered are: Why do you have such a large amount of credit card debt? Have you started an emergency savings account of six to 12 monthsí worth of living expenses, so you wonít have to use credit for unexpected expenses? Do you have a workable spending plan that includes putting money aside for future financial goals?

If you donít know why or how you amassed $50,000 in credit card debt, start there. You need to understand how you got in that position if you are going to avoid getting there again and again. Only then will you steer clear of the financial disaster of racking up a new five- or even six-figure debt load after you consolidate.

Funding an emergency savings account should help you better manage unexpected expenses as they occur, but if your main problem appears to be that youíre extending your income with credit, you need a spending plan. You need a plan that brings your expenses in line with your income and one you will commit to follow. Without taking these positive money-management steps, consolidating your debt will not help your credit rating in the long run but instead could create the potential for disaster.

In addition, your spending plan will help you determine if you can afford to consolidate your credit card debt. According to Bankrate, interest rates on personal loans currently average 9.51 percent (as of April 11). With your good credit rating, letís say you qualify for a loan at 10 percent interest.

You would need to pay $1,062 per month for five years to pay off your $50,000 in credit card debt. Should you need to cut back on expenses in other areas to afford the consolidation loan payment, be sure youíre willing to make the necessary sacrifices for the entire five-year repayment period, and be doubly sure you donít use those cards unless you can pay them off in full each month!