Getting into credit card debt can be surprisingly easy: you spend a little here and there, maybe you had to replace a car part, and then perhaps you made a cross-country trip to attend a wedding.
All of a sudden, those charges add up to thousands of dollars toward your credit card balance.
Then, the stress and psychological burden of debt begins. If you can’t make the minimum payments, you might have creditors or collection agencies calling while your debt grows larger.
It’s not a fun scenario and may have serious repercussions for your fiscal future.
However, racking up serious credit card debt doesn’t have to mean financial ruin. One option for dealing with your debt is consolidation, which rolls your credit card debts over into one loan.
Read ahead for options on consolidating your credit card debt, or navigate to the section directly relevant to you.
- What is Debt Consolidation?
- Debt Consolidation: Credit Cards and Loan Repayment Plans
- Credit Card Refinancing or Balance Transfer
- Personal Loan
- Home Equity Loan
- 401(k) Loan
- Debt Management
- Avoiding Debt after Consolidation
What is Debt Consolidation?
Debt consolidation is a method of restructuring your credit card debt. Basically, your various debts are lumped into one monthly payment — a payment that comes at possibly a much lower interest rate.
For example, if you are paying multiple interest charges across multiple credit cards, you are likely paying large amounts in interest without seeing much of a difference in your balance.
Through debt consolidation, you may reduce the overall amount of interest you’re paying by locking into a singular interest rate.
Debt Consolidation: Credit Cards and Loan Repayment Plans
When you consolidate your debt, it can have a positive effect on your overall financial circumstances because it may help you pay off your debts faster.
Debt consolidation may help improve your credit score by lowering your overall credit utilization ratio – that’s the amount of credit you’re using compared to the total available amount of credit.
Some creditors like to see a utilization of 30% or less of your available credit. If you have multiple credit cards that are close to their credit limits (or completely maxed out), that sends your utilization ratio skyrocketing.
Let’s take a closer look at the best ways to consolidate credit card debt.
Credit Card Refinancing or Balance Transfer
A balance transfer card can be a great way to eliminate debt interest-free.
It works like this: you transfer the balance from one card to another, in the hopes of landing a better interest rate.
Balance transfer cards usually boast a 0% APR introductory period that typically lasts 6 to 12 months on average – make sure to read the fine print to figure out the exact period.
The one caveat with a balance transfer card is that you must pay off your debt before the introductory period is over. Otherwise, you may incur large interest charges.
With balance transfer cards, there’s no prepayment penalty and if you’re sure you can pay off your total debt within that 0% interest period, it could save you a ton of money – assuming you don’t take on more debt.
However, you may need a good or excellent credit score to get a balance transfer card and you’ll face deferred interest charges should you fail to pay back your debt by the end of the intro period. You also might have to pay a balance transfer fee (usually around 3% to 5% of the transfer amount).
Other considerations: You may consider moving balances over to the new balance transfer card as soon as you can because the introductory 0% interest is usually only valid if you use it within a set time period – 60 days, in some cases. It’s important to stay current with your payments, otherwise your 0% introductory period could end prematurely as a consequence.
What to look for in a balance transfer card: 0% APR period, $0 introductory balance transfer fees, and a card with rewards to use after you’re debt free. Don’t be tempted to use a balance transfer card for purchases even if it comes with perks — as it could only deepen your debt.
However, personal loan lenders may have tight requirements as well, so it’s important to examine your options. Personal loans may be secured (borrowed against collateral) or unsecured (no collateral).
Benefits of a personal loan: Because payments are the same each month, you may find your payments more manageable.
Interest rates for unsecured personal loans can vary: from 5% all the way to 36%.
If you have a lower credit score, you may be slapped with a higher interest rate. You also might be charged origination fees.
If you get a credit card debt consolidation loan, consider first using the loan money to pay off your credit cards.
When your credit debts are squared away, consider how to pay off your personal loan, perhaps by setting up an auto-pay system to avoid late fees or by setting aside payments each month.
Home Equity Loan
Home equity loans are another way to pay off and consolidate your credit card debt: they are typically intended for a fixed amount of time at a fixed interest rate. However, the major drawback is the loan is secured by your home; if you default on your payments, you could lose your property.
A loan using your retirement savings is another option to get rid of your credit card debt but only in certain circumstances: for instance, if you’re sure you’re going to be at your current job for the period you’ll be paying back your loan.
You generally have five years to repay the loan and the interest you pay on the loan is to yourself, not a lending institution. And generally, the repayment structure is simply automated payroll deductions.
Typically, these loans have lower interest rates than credit cards.
The drawback with this type of loan is the high risk you’re taking on. If you suddenly lose your job, the loan is due within two months. If you can’t pay it back by that time, you are vulnerable to penalty fees.
This isn’t a great choice if you’re looking to make any kind of career moves within the near future or if you think you’ll be laid off for any reason.
If you do go this route, the money you take out should go repay your credit card debts — but be sure to talk to a financial adviser about the best course of action. Payments will be taken out of your paychecks in most cases but if this isn’t the case, make on-time payments anyway to avoid paying any penalties.
Debt Management Plans
A debt management plan (DMP) consolidates credit card payments, and is not a loan.
Typically, debt management companies will work with creditors on your behalf to reduce your monthly debt payment and your interest rates.
Both parties can then agree on affordable payment schedules that typically provide up to 5 years to pay off debt.
Benefits: Your counselor might be able to secure lower rates and fees. You should seriously consider this option if you are having trouble making the minimum required payments but have a secure, stable income.
While your DMP is active, you will have fairly severe limits placed on your ability to use credit – most of the time, your credit cards will be suspended and you won’t be allowed to open new lines of credit.
And, you may be charged fees for your enrollment in the plan and monthly fees, and this kind of plan may have a negative impact on your credit score.
Avoiding Debt after Consolidation
Massive credit card debt is often the result of overspending. The best way to avoid debt in the future: curb unnecessary spending and take a hard look at your financial patterns.
Once you have your consolidation plan in place and you’re making payments, don’t fall into the same habits that led you there in the first place. Here’s a few actionable tips that could help you stay on track:
- Follow a budget, and try to keep track of where your money goes each month.
- Make sure to pay all of your bills on time – if you’re able, set up automated payment so you won’t incur late fees or suffer from a credit score dip.
- Consider setting up an emergency fund instead of relying on your credit card to get through unexpected expenses.
- Know your habits: don’t get a credit card that offers rewards and overspend to get those rewards.
Keep tabs on your credit, especially if you’re trying to raise your score after a period of financial trouble. This will help you stay on top of your financial health and keep you abreast of any changes in your credit report.