Steps To Consolidate Credit Card Debt

Posted on January 12, 2021 in Credit Cards

Attempting to juggle paying off multiple credit card debts can be quite challenging, and if not done correctly, could result in financial consequences such as interest payments and late fees. 

The 2019 Experian Consumer Credit Review found that the average American has four credit cards, and with the average credit card debt being in the thousands, it could end up being a mighty struggle to keep all the cards paid off. 

One of the best ways to help eliminate credit card debt is with a process called consolidation. 

What is Debt Consolidation?

Debt consolidation is when someone uses a new loan or credit card in order to pay off an existing debt or debts. The idea is to bundle multiple credit accounts into one with a more favorable interest rate. 

Even if it is only one account attempting to get a lower interest rate could save money as well. Along with the lower interest rate another benefit is just having one monthly payment to keep track of instead of several. 

Things To Consider Before Consolidating Debt

Having multiple credit accounts open and trying to pay them all off can be a struggle to keep up with, but depending on some factors, may actually be the best option. 

The following options should be considered before attempting to consolidate debt, as it may end up actually complication your financial situation:

  • Credit Score: For debt consolidation to reach its maximum potential of effectiveness, a good or excellent credit score is crucial. It’s possible that taking a new loan with a lower credit score could result in a higher interest rate than the one trying to be avoided. If a credit score is anywhere below 670, then the first priority is to raise that as high as possible.
  • Budget: Depending on the option used for consolidation, it is possible to end up with a higher monthly payment than the current total of all the accounts. Credit cards typically require a minimum monthly payment around 1% to 4% of the balance, and do not have a required time to be paid back. On the other hand, a personal loan has a set time and is broken down evenly into the amount of months the loan is to be repaid in. As a result the payments may end up being much higher per month.
  • Debt Load: Credit card consolidation is only really effective if the borrower can make the current minimum monthly payments. If this is not possible, then consolidation will not do very much to help or change that. In the case of extreme credit card debt, other options such as debt settlement or even bankruptcy might be necessary to consider.

Types of Credit Card Debt Consolidation

If everything listed above is met, then it’s time to consider the best type of consolidation for the specific details of an individual. Ultimately the end goal is the same, but there are many different ways to get there. 

  • Balance Transfer Card

Anyone with good or excellent credit should consider this option first when attempting to consolidate their credit card debt. Typically these cards will offer low or even 0% interest rates via promotional periods that last from 6 to 18 months. The idea is that once this new line of credit is activated, then the borrower would transfer the balance from the other accounts onto this new card and pay it off within the time of the promotional interest rate. Failure to do so would result in the interest rate jumping up to a higher rate, and may result in paying more money in the long run. Also when transferring a balance to the new credit card, there will likely be an upfront balance transfer fee. There are some options of cards that offer no fee transfers but typically most will charge 3% to 5% of the transfer amount. 

  • Personal Loan

This option is best utilized if the borrower has good or excellent credit. Unlike a balance transfer card with promotional periods of little to no interest and no set repayment plan, a personal loan has all the details locked in from the start. Personal loans are offered by banks, credit unions and online lenders with a wide variety of interest rates and terms. Federal credit unions can not charge more than 18% interest but with banks and online lenders it can sometimes be as high as 36% interest, depending on credit, although typically it will be around 10% or less. The loan total with the interest rate will be figured up and broken down into even monthly payments for the total amount of time allowed for repayment which is generally between 36 and 60 months.

  • Home Equity Loan

Anyone that owns a home and has been paying on their mortgage has equity. Equity is the difference between what is owed on the mortgage and what the home is currently worth. So, if a house is valued at $300,000, and $200,000 is owed, then the equity would be $100,000. With this option the interest rate would almost certainly be the lowest of any of the others, but the house would become collateral. This means that failure to pay back this loan could result in a foreclosure of the house. These loans are generally for a much higher amount of money than standard personal loans, so if the credit card debt is bad enough, this may be the only option.

  • Retirement Account Loan

One of the better options for someone with poor credit could be to look into their retirement account for a little bit of help. Employer-sponsored retirement accounts such as 401(k) and 403(b) do not require a credit check if the retirement plan does indeed offer the option of a loan, as not all do. Generally the interest rate will be lower than that of a bank or online lender, which is another added benefit. However, if the payments are not made then the amount that was withdrawn could be taxed along with a penalty, and additional fees on top of that. Another potential downside is the funds that are being borrowed will not be earning interest, and that would hurt the growth of the retirement income.

  • Debt Management Plan

Depending on the success of finding a balance transfer card or personal loan with favorable rates, it may be a good idea to contact a credit counseling agency that can help set up a debt management plan. This option would have a credit counselor go over all the financial details and attempt to negotiate lower interest rates, debt forgiveness or lower monthly payments. However, this plan does come with some substantial risks. On top of the fee charged by the agency, any individual choosing this option will almost certainly have their credit scores impacted negatively. With a debt management plan, the borrower will stop paying back money to the lender and will instead make monthly payments to the agency who will then pay the lender. As a result, the account is often reported to the credit bureaus as late and eventually delinquent which both have negative consequences on a credit score. This option could take up to a few years to pay back all the money as well so although it may save some money in the end the damage done to the credit report is something to keep in mind.

The Takeaway: There are many different ways to consolidate credit card debt depending on various financial details. Bundling up several payments and rolling them into one can go a long way to helping making repayment much easier and much cheaper.

Credit card consolidation has many benefits for anyone looking to get rid of their credit card debt and avoid falling too far behind. Ultimately, having the best credit possible is the easiest way to consolidate credit card debt, but it is not a necessity as there are other options that can help achieve the goal as well. 

Attempting to get the lowest interest rate possible is the most important thing but even just having one payment instead of several can go a long way toward getting in the habit of paying down the debt and reducing the additional charges in the long run. 

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