Consolidating Credit Card Debt Could Help Simplify And Lower Your Monthly Payments As You Work To Become Debt
Consolidating credit card debt is when you combine multiple credit card balances into a single monthly payment that ideally has a lower interest rate than what youre currently paying.
But consolidating your debt takes time, and many methods require an application process to see whether youre approved first, which usually results in a hard credit inquiry that can cause your credit scores to drop a few points.
To help you decide if credit card consolidation is right for you, here are several methods to consider.
Pros And Cons Of Consolidating Credit Card Debt With A Balance Transfer Card
You can certainly use a debt consolidation loan to consolidate just credit card debt if you have multiple credit cards, but if your credit score is excellent you may be able to qualify for a balance transfer credit card.
A balance transfer card allows you to consolidate credit card debt by moving your high-interest debt from one card to another, typically with a 0% introductory APR offer. Just like with debt consolidation loans, there are pros and cons of consolidating credit cards via balance transfer.
You Could End Up Deeper In Debt
When you pay off credit cards using the proceeds of a personal loan, you free up your line of credit. If you use these cards again and cant pay off the balance, you could end up owing your original creditors again.
But now youd have to pay off your consolidation loan and a bunch of new debt, leaving you in worse shape.
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You Want To Create A Debt Freedom Deadline
If you have credit card debt, getting to a zero balance isn’t always as clear as it is with other debts. Credit cards, for example, allow you to keep adding to your balance. If you spend more than you can pay off in full each month, you’re going to find yourself buried in a deepening pit.
On the other hand, installment loans come with a fixed number of payments and lead to a zero balance with the final payment. Popular personal lenders offer fixed and flexible terms.
If you can convert credit card debt into an installment loan balance, you’ll know exactly when your balance will be paid off. By paying off credit card debt and putting the debts into three- or five-year installment loans, debt freedom could be just over the horizon.
You May Not Get Approved For A Lower Interest Rate
The interest rate you receive for any new loan or line of credit will depend on your . Generally, a higher credit score will allow you to qualify for lower interest rates, while a lower credit score will land you higher interest rates. It’s also a good idea to not apply for a new loan if you’ve recently applied for other lines of credit since too many hard inquiries on your credit report can lower your credit score and lead to higher interest rates. Personal loan and debt consolidation lenders do accept applicants with less than ideal credit scores while you’ll be approved for the loan, you’ll likely receive a higher interest rate if your credit score is on the lower side.
Debt consolidation works best when you are able to receive an interest rate that’s lower than the rates you’re paying for your current debts. Many lenders allow you to check what rate you’d be approved for without hurting your credit score so you can make sure you’re okay with the terms before signing on the dotted line.
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Smart Ways To Consolidate Credit Card Debt And 5 You Should Never Do
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Consolidating high-interest credit card debt with a lower-interest credit product could help you wipe out the debt faster and pay less interest.
In theory, consolidating credit card debt sounds like a good idea. Replacing high-interest credit card debt with a credit product that has a lower interest rate could help reduce the amount of interest you ultimately pay on the debt.
There are a number of ways to consolidate credit card debt all of them with their pluses and minuses. Some choices are better than others. But the goal of all of them is basically the same: to combine your high-interest debt, leaving you with one monthly payment at a more reasonable rate.
If youre considering consolidating your debt, its important that you find the option that works best for you and offers you the lowest-cost way to get out of debt.
Decide If Using Your Credit Card Is Wise
The average annual interest rate or APR charged on credit cards reached 26.6 per cent in May 2022, analysis by Moneyfacts shows, the highest since the comparison website started collecting data in 2006.
As the interest is so high, the stress of owing money can outstrip the benefit of taking on more debt, says Ms Haine, particularly if there is any threat to your employment or other means of being able to pay back what you borrow.
The first step is to understand why you need to take on some credit, she continues. A short-term fix, such as fixing a faulty appliance or fixing your car, is a good use of your credit card so long as you can repay the balance at the end of the month.
If there is an ongoing need to borrow, such as to plug a short-term gap in your income versus expenditure, then a credit card may not be the answer, Ms Haine adds.
Before making any applications for credit products, it is worth remembering that even a search on your payment history by a company can be recorded on your credit report. With too many searches, your credit score can become reduced.
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What Are Some Effective Strategies For Paying Off Debt
What are some effective strategies for paying off debt? Once you consolidate and streamline your debt, its time to get down to business and reach that zero balance. It takes planning, support, discipline, commitment and some strategies to put into action. As you start your debt repayment journey, these six strategies can help you reach your zero-debt destination.
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Debt Consolidation Won’t Keep You Out Of Debt
Lastly, while consolidating your debt may help you to pay it off faster, the loan itself won’t keep you out of the debt cycle. Many borrowers mistakenly believe debt consolidation doesn’t work for them because shortly after becoming debt-free, they fell back into old habits and eventually, more debt.
Debt consolidation itself is just another tool meant to alleviate multiple high-interest monthly payments. It’s important to figure out what causes you to go into debt in the first place. According to financial expert and author Paco de Leon, many people may have certain certain root causes, like overspending when they’re stressed out, which push them to rack up credit card debt they’re unable to pay off. It can be really helpful to speak to a financial therapist or a financial advisor if you’re having trouble keeping the debt away.
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What Does It Mean To Consolidate Credit Card Debt
Like any other debt consolidation program, credit card debt consolidation is basically bringing all your scattered multiple credit card payments under one joint payment scheme. Consolidating debt simplifies your monthly payments, can reduce interest rates, and ultimately frees up more opportunities to save. There are multiple ways that you can go about this.Three primary factors determine the best consolidation option:
- The amount you decide to pay off
- Your current financial state to support that decision
- The strength of your credit history for more flexibility
Borrow From Insurance Policy
How it works
Some types of life insurance have a “cash value” based on how much youve paid into the policy and how long youve had it. You may be able to borrow up to the cash value of your policy from your insurer.
Pros of borrowing from an insurance policy
- May have tax advantages. Loans taken from a life insurance policy may have tax advantages, like not having to pay income tax on the money.
Cons of borrowing from an insurance policy
- May reduce the death benefit. If you dont pay back all the loan, the benefit received by your family when you die decreases.
When you might consider it
If you have a significant cash value in your policy and have a plan to quickly repay the loan, this might be an option for you.
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Prep Your Credit Profile
Interest rates are heavily dependent on credit scores, so Rafferty recommends applying for a consolidation loan with the best possible credit profile.
In most cases, higher credit scores bring lower interest rates, said Rafferty. There are cases where lenders will still be able to lend consolidation loans to consumers with poor credit scores, but the caveat is a much higher interest rate.
Its also helpful to know your debt-to-income ratio. Rafferty said many lenders will require it to be less than 40%.
Ask A Friend Or Family Member For Help
Depending on how much money you owe and what your overall financial picture looks like, it may make sense to ask a friend of family member to lend you the money.
But if you opt for this method, its important to be sure the loan terms and repayment plan are clearly outlined, just as they would be if you were getting a loan from a financial institution.
Pros: When you borrow money from somebody you know, you dont have to meet minimum eligibility requirements to qualify for the loan, and you may be able to get a lower interest rate than you would from a bank or credit union.
Cons: Borrowing money from someone you know is tricky because it can put a strain on your relationship. Also, if youre unable to repay the loan on time, you might be putting their finances at risk.
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Youd Be Using A Secured Loan Or Line Of Credit
Another way to consolidate debt, particularly for consumers without the best credit, is to get a secured loan or line of credit. A home equity line of credit is a popular choice.
Opinions are mixed on this, but Id only recommend it as an absolute last resort. Credit card debt is unsecured. Although it isnt good to default on a credit card, at least the card issuer cant repossess your assets for it.
If you consolidate your credit card debt with a HELOC or any secured financing, youve gone from unsecured debt to secured debt and put an asset at risk.
Take Out A Personal Debt Consolidation Loan
Personal loans are unsecured and can be used for many different things, including debt consolidation. Their interest rates will vary, depending on your credit score, with 24-month personal loan interest rates ranging from 10.36% to 10.63% in 2019.
Benefits of personal loans for debt consolidation
- Depending on your credit score, they might carry a lower APR than your credit cards.
- They usually offer a longer term than a balance transfer card’s low or no interest rate promotional period.
Drawbacks of personal loans
- A personal loan might not offer a lower interest rate than your credit cards, if your credit score is poor.
- Personal loans may charge origination fees.
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See If You Qualify For A Balance Transfer
A balance transfer could be a good way to consolidate your existing debt and make it easier to pay off. This especially applies if you’re able to snag a 0% introductory rate offer.
But be careful — balance transfers can trip you up if the fees to move your balances over are high. And also, for a good offer, you’ll need decent credit. If you don’t have that, you may not qualify for an offer worth pursuing — or you may not be able to do a balance transfer at all.
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Missing Payments Will Set You Back Even Further
If you miss one of your monthly loan payments, youll likely have to pay a late payment fee. In addition, if a payment is returned due to insufficient funds, some lenders will charge you a returned payment fee. These fees can greatly increase your borrowing costs.
Also, since lenders typically report a late payment to the credit bureaus after it becomes 30 days past due, your credit score can suffer serious damage. This can make it harder for you to qualify for future loans and get the best interest rate.
To reduce your chances of missing a payment, enroll in the lenders automatic payment program if it has one.
Takeaway:Before you take out a debt consolidation loan, make sure you can afford the monthly payments. Missing a payment can lead to late fees and a lower credit score.
When Is Debt Consolidation Not A Good Option
Debt consolidation isnt worth the effort if you cant qualify for a lower interest rate and can afford your current monthly payment. In this situation, try making extra payments when possible.
Consolidating also isnt worth the effort or expense if you only have several months or less than two years of payments remaining.
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Debt Relief Through Bankruptcy
Theres little point in entering a debt settlement or debt management plan if youre not going to be able to pay as agreed. We recommend talking with a bankruptcy attorney first, before you pursue any debt relief strategy. Initial consultations are often free, and if you dont qualify, you can move on to other options.
The most common form of bankruptcy, Chapter 7 liquidation, can erase most credit card debt, unsecured personal loans and medical debt. It can be done in three or four months if you qualify. What you should know:
Also, not everyone with overwhelming debt qualifies. If your income is above the median for your state and family size, or you have a home you want to save from foreclosure, you may need to file for Chapter 13 bankruptcy.
Chapter 13 is a three- or five-year court-approved repayment plan, based on your income and debts. If you are able to stick with the plan for its full term, the remaining unsecured debt is discharged. It will take longer than a Chapter 7 but if you are able to keep up with payments , you will get to keep your property. A Chapter 13 bankruptcy stays on your credit report for seven years from the filing date.
How Much Can You Save
Debt consolidation loans and credit cards often come with lower interest rates. For instance, if youre paying 25-30% right now, you might be able to get rates as low as 12-15% . But if youre not being quoted lower interest rates than youre currently paying, consolidating your debts may not be your best option.
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Are You Limiting Debt Relief Options Down The Road
Another situation you want to avoid is limiting the options you have available for debt relief once youve used the option youre considering now. For this example, well look at student loan debt consolidation.
Its possible if you have student loan debt that you can carry both federal and private student loans. Federal loans are Direct, Stafford, FFEL and PLUS loans for parents and graduates. Private student loans come through a financial institution or private lender. Some borrowers just have one type or the other, but some have both.
Once you begin repaying your loans, you may decide to use debt consolidation to make it easier. There are five federal student loan repayment plans that allow you to consolidate federal student loan debt, but wont apply to any private loans you hold. By contrast, a private consolidation loan provider will be more than happy to consolidate both for you, but theres a catch
If you consolidate federal student loans into a private consolidation loan, those loans effectively become private. That means that later if the consolidated loan still isnt working for you to eliminate your debt, you wont be able to use those five federal programs. Whats more, if youre a public servant, you also make yourself ineligible for public service student loan forgiveness programs that the federal government also offers.