5 Ways to Consolidate Credit Card Debt
When the end of the month approaches, you find yourself overcome with anxiety. You’re past due on all of your credit card payments again, and your debt is piling up. You now have five credit cards, each with a significant amount of debt, as well as skyrocketing interest rates and monthly fees that are through the roof.
If you’re struggling to pay back credit card debt across multiple cards, consolidating that debt might be worth considering. You can consolidate credit card debt using various strategies, each with its own pluses and minuses.
Here’s everything you need to know about the benefits of consolidating credit card debt, as well as a breakdown of the most popular methods.
The benefits of consolidating credit card debt
There are a handful of benefits that come from consolidating credit card debt.
“If you do it right and make the choices that are best for you, the benefits can include lower interest rates, lower fees and a faster timeline to clear your balance,” said Bruce McClary, vice president of communications for the National Foundation for Credit Counseling (NFCC).
Some of the perks one can reap from consolidating credit card debt include:
Fewer monthly payments – When you consolidate credit card debt, you’ll likely have all of your debt in one place. Many people benefit from having one monthly payment instead of five or six, as it keeps them on track.
Lower interest rates – If you transfer your outstanding credit card balances to one credit card or you obtain a debt consolidation loan, you will likely be able to obtain a lower interest rate, saving you additional money as you pay off your credit card debt.
Potentially lower monthly payments – If you secure a lower interest rate with your new line of credit, your monthly payments will likely be lower, too. In addition, you might be able to pay off your debt over a longer period of time when you consolidate it. Debt consolidation loan repayment is typically paid within 24 to 60 months.
Improved credit score – If you convert your revolving credit card debt into installment debt by obtaining a debt consolidation loan, your credit score can benefit. “Installment debt is almost completely benign to a credit score, where revolving debt can be very problematic,” said John Ulzheimer, founder of The Ulzheimer Group and a credit-reporting expert formerly of FICO and Equifax.
But, but, but. It should be noted, however, that people who take on a debt consolidation loan might see a dip in their score right at first, as lenders will need to do a hard pull of the borrower’s credit, which can slightly lower the score. However, this score should eventually increase if you pay back your debt consolidation loan.
When is debt consolidation a bad idea?
It’s also worth noting that consolidating credit card debt isn’t for everyone. Consumer credit experts interviewed for this story note that debt consolidation isn’t wise if your total credit card debt is more than 50 percent of your annual income. Additionally, it might not be a sage decision if you don’t have a steady source of income, as missing monthly payments will only set you back further.
In addition, some people with less-than-stellar credit scores might struggle to secure the financing they need to consolidate their credit card debt. If you can’t secure a lower interest rate by consolidating your debt, it might not be the right option for you.
5 ways to consolidate credit card debt
Ready to get started? These are the five most popular ways to consolidate credit card debt.
Debt consolidation loan
- Interest rates are typically fixed and lower than credit card rates, especially for those with good credit.
- Not so good credit? You can obtain a personal loan with a credit score as low as 580.
When people hear the term debt consolidation, they’re likely thinking of a debt consolidation loan, said Gerri Detweiler, a consumer credit expert and author of “Debt Collection Answers: How to Use Debt Collection Laws to Protect Your Rights.” Debt consolidation loans are personal loans taken out to consolidate and pay back debt. These loans still have interest, though the rate is likely lower than that of a credit card — however, rates vary significantly and the best rates usually go to those with the best credit.
The advantage of a personal loan is that it typically offers a fixed rate versus a credit card’s variable rate. The amount that can be borrowed ranges anywhere from $300 to $100,000. Ideally, this type of loan will cover the cost of paying back all of your credit card debt through one monthly payment.
Detweiler said this is often the most appealing option for people looking to pay off significant credit card debt. “The idea that you get a loan to pay off other debts, and then you just have one monthly payment — hopefully at a fixed rate or a fixed amount — that’s pretty attractive,” she said. “It’s definitely the gold star of debt consolidation, and done right, it can be beneficial to both your finances and your credit.”
Ulzheimer said one of the major benefits of taking out a personal loan to consolidate and pay off credit card debt is that your interest rate will likely be much lower. “This way, you’re consolidating the debt into one loan versus multiple cards,” he said. “So the benefit there is you’re converting revolving debt to installment debt, and it’s likely going to be considerably less expensive.”
The psychological benefit. McClary said one primary benefit of debt consolidation loans as opposed to other repayment methods, such as balance transfers, is that they keep consumers on track, as they don’t have the temptation that comes from having an available line of credit.
“It really keeps you focused on the payoff and on track toward your goal a little bit better than maybe moving the debt over into another credit card account where you’re likely to have room to add additional charges and grow the balance instead of shrink it,” he said.
Detweiler said that one caveat of this method is that this type of loan can be difficult to qualify for if a consumer’s credit is in bad shape. “The challenge is that if you have a lot of debt, especially high balances on credit cards, your credit score may have taken a hit,” she said. “So it could be a little challenging to qualify [for a debt consolidation loan], especially for a lower interest rate.”
Information on the best debt consolidation loans can be found here.
Credit card balance transfer
- Interest rates as low as 0%, usually for a limited time
- But be careful of strings attached: transfer fees and deferred interest
Another popular method for consolidating credit card debt is transferring balances with high monthly interest rates to a single credit card with a lower monthly interest rate.
The ideal situation, Ulzheimer said, would be transferring the balances to a newly opened card that has a promotional 0 percent APR grace period. These grace periods typically run anywhere from six months to a year, he said. We’ve seen them for as long as 21 months. Paying back all or a substantial portion of your debt during this time period could save you a significant amount of money.
“If you’re fortunate enough to consolidate [your debt] onto a newly opened balance transfer credit card and your credit is good enough, then you may be able to consolidate interest-accruing debt onto a newly opened card that has some sort of zero interest grace period,” Ulzheimer said. “The benefit is that it gives you some time at a reduced cost to try to get out of a debt.”
Typically, consumers need a good credit score (700 minimum) to qualify for a good balance transfer credit card. And if you miss a payment on your balance transfer credit card, know that the 0 percent APR promotion might end. In addition, it’s worth noting that you cannot transfer balances from the same credit card issuer.
Ulzheimer adds that a balance transfer is ideal for people with $3,000 or $4,000 in credit card debt who can likely pay it back in a year, as opposed to people with tens of thousands of dollars in debt.
“If you can’t pay it off before the zero [percent APR] grace period expires, then you’re probably going to have to pay interest retroactively back to the first day that you opened the card, or when you roll the balance off of the card,” he said.
McClary warns consumers that although some cards offer free balance transfers, many cards will have balance transfer fees that might negate the lower interest benefit. “You have to keep in mind though that there are balance transfer fees, so although there’s an opportunity for savings here, some of that savings might be undercut by the balance transfer fee,” he said. “So you really have to do the math before you decide which opportunity is best for your circumstances.”
McClary also advises consumers to look at the credit card’s terms after the introductory grace period ends, and make sure you’re comfortable with those terms.
“Once that interest rate goes to the regular rate, is that something you’re going to be able to live with?” he said. “Are there any other fees or costs of carrying the card that you feel are competitive compared to other offers? It’s not just the short term you have to be thinking about. It’s also the long term.”
Learn about various balance transfer credit cards here.
Debt management plan
- A solution a certified credit counselor might suggest.
- Beware of debt relief firms — they aren’t the same as certified credit counselors.
If your credit isn’t in great shape, you might struggle to qualify for a balance transfer credit card or a debt consolidation loan. But don’t worry. There are still options out there for you.
“If you’re having trouble qualifying for a debt consolidation loan or balance transfer, or other forms of credit that require a decent credit score, then a credit counseling agency might be the next place to go,” Detweiler said.
Nonprofit credit counseling agencies will not take your credit score into consideration and will help you create a debt management plan. These plans aren’t the same as true debt consolidation loans, Detweiler said, but they function similarly. Depending on your situation, you will likely make one or two monthly payments to the agency, who will then disperse your payments to your various creditors.
“Just in terms of convenience and peace of mind, it can help you tackle that debt in a very effective way if it works for you,” Detweiler said.
McClary emphasizes the myriad benefits nonprofit credit counseling agencies can provide. In addition to helping people pay back debt, they can also teach consumers about sustainable, healthy money habits. “They can help you customize so you’re not just doing a one-size-fits-all plan,” he said.
In addition, Ulzheimer said these agencies can often stop negative credit reporting because they have agreements with card issuers not to report negative information to the credit bureaus as long as a consumer is sticking with his or her program. “You’re going to pay back the majority of what you owe, and you’ll exit their programs with good credit as well,” he said.
Find your nearest nonprofit credit counseling agency here.
Home equity loan
- Lower interest rates than personal loans but higher risks.
- Upfront fees — including closing costs — might eat into the savings.
Consolidating high-interest credit card debt and paying it back with a home equity loan is an option for people with significant credit card debt. But most consumer credit experts warn against using this strategy. Although the lower interest rate and potential savings of a home equity loan can be tempting, you should make sure you’ve exhausted all of your other options before considering a home equity loan.
The main risk of a home equity loan, Detweiler said, is that you’re trading unsecured debt for secured debt. The worst-case scenario for unsecured debt, like credit card debt, is that you will be sued. The worst-case scenario for secured debt like a home equity loan is that you’ll lose your home.
“While you may end up with an interest rate that is lower and there may be net savings for making that move if you miss payments, then what’s at stake is the roof over your head,” McClary said.
A home equity loan is not out of the question for consolidating and paying back credit card debt, McClary said, so long as you’ve done your due diligence and know what you’re getting into.
“If it’s something you can do affordably, and if it helps you clear debt out of the way that would otherwise be very costly and very difficult to manage, it’s certainly an option to consider,” McClary said. “But I would say do it with caution.”
Compare various home equity loans here.
- It’s possible to borrow from an employer’s retirement plan or even withdraw contributions made to an IRA, but that doesn’t mean you should.
- One benefit: No credit check.
Like home equity loans, 401(k) loans can be a tempting way to pay off credit card debt. Your credit score isn’t checked for this type of loan, and you’re essentially borrowing against yourself. One benefit of 401(k) loans is that they don’t show up on your credit reports, meaning your credit score could see a slight boost as you pay back your debt. In addition, these loans can be easier to secure than a loan from an outside lender, and they can be accessed quickly.
But McClary warns consumers against using a 401(k) loan to pay off credit card debt.
“In terms of 401(k) loans, I have always said this — and I will say it again — that should be one of the very last options that you consider,” McClary said. “I would strongly recommend not going down that road because you don’t want to borrow the money that is there to help you live a financially secure life after your income stream stops.”
In addition, if you lose your job, the stakes will be even higher.
“The danger with an outstanding retirement loan is that if you were to lose your job or if you can’t keep up with the payments, you may potentially have a taxable event, which could be very expensive,” Detweiler said.
The bottom line
Regardless of your strategy, consolidating and paying off significant credit card debt can be an immense challenge.
“Getting out of credit card debt is almost like losing weight,” Ulzheimer said. “Conceptually, it’s a great idea. There’s a ton of upside. Everyone acknowledges that. But the minute you start doing it, you realize that it really stinks. And so one of the challenges is training yourself so that you don’t get burned out and give up a month or two months or three months into the program.”
Contact your local nonprofit credit counseling agency for advice on how to stick to your debt repayment plan and maintain good financial habits. Once you’re completely free of credit card debt, you’ll be glad you persisted through the difficult times.