Guide to Credit Card Debt Consolidation

If you’re anything like the average American, it’s likely that you are in debt to some degree. If credit card debt is the root of your financial problems, it might be time to consider credit card debt consolidation. 

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What is credit card debt consolidation?

Credit card debt consolidation is a plan of action that combines all of your credit card balances so that you can manage all of your credit card debt with one single monthly payment.

While this might seem like a surefire way to approach this issue, there are some drawbacks. For example, depending on what route you choose, it could add marks to your credit score. 

The below information will walk you through the basic ins and outs of credit card debt consolidation so that you can decide whether or not it is the right choice for you. 

Advantages of Credit Card Debt Consolidation

There are three major advantages to consolidating your debt. Let’s take a look at them:

  • keeps things simple: This is a situation where the “less is more” rule applies. Our lives are already busy enough without having to worry about managing multiple credit accounts. Just remember that your loan’s annual percentage rate (APR) needs to be considered too and steering clear of higher interest rates should outweigh convenience, which leads us to our next point…
  • Lower interest rate: It’s possible that consolidating your debt could lead to a lower interest rate. If this works out as a result of credit card debt consolidation, it can scrape years off of your estimated dept repayment time.
  • A higher credit score: When you max out your credit cards, your utilization ratio—or utilization rate, which is the amount of available credit you are using on your credit card—goes through the roof. High utilization rates can negatively impact your credit score big time. When you consolidate your debt into one loan, the utilization on your cards decreases tremendously which will ultimately add points to your credit score. 

How to Get Started with Credit Card Debt Consolidation 

Credit card debt consolidation isn’t a one-size-fits-all strategy. The best way to go about consolidating your debt is going to depend on:

  • How much debt you have
  • Your credit score and credit history
  • Whether or not you have investments or home equity in a 401(k) account.
  • Self-discipline

Credit Card Refinancing 

Credit card refinancing can be a good option to managing personal debt for those of us who have a good credit score—think 690 and above on the FICO scale. With credit card refinancing, your credit card debt will transfer to a balance transfer credit card with no introductory APR, meaning that you won’t be charged interest for the first 12 to 18 months.

It’s more than likely that the issuer is going to charge a balance transfer fee, which is usually about 3% to 5% of the transferred amount. Keep this in mind before getting your heart set on a card and make sure to do the math on the interest.

A couple of things to ask yourself if you are considering this as an option:

  • Will the 0% interest make up for the balance transfer fee?
  • Can I come up with a budget that would allow me to pay off my debt in a 12-18 month period before the APR kicks in? 

Credit Card Consolidation Loan

Taking out a personal loan from a bank, online lender, or credit union is another common way of consolidating credit card debt. Through this method, it’s more than likely that you will receive a lower APR on your debt. So, which entity should you go through to apply for your loan? The short answer is that there are benefits to each: 

  • Credit unions are non-profit lenders. A lot of times, they are able to propose more workable terms and much lower rates than the other contenders. This is a good option for those of us with bad to fair credit. 
  • Online lenders will usually allow you to pre-qualify for a loan without costing you any wear and tear on your credit score. A lot of online lenders will present you with an estimated rate accompanied by a soft inquiry on your credit. Most banks and credit unions won’t do this. Additionally, they might offer to directly pay your creditors for you, which makes this process that much easier for you. 
  • Bank loans are good at offering low APRS to customers with good credit. If you borrow from a bank that you are already a member of, they might be able to offer you a heftier loan as well as discounts on certain rates. 

A couple of things to keep in mind when considering a consolidation loan are:

  • It’s going to be harder to get a lower monthly rate if you have a bad credit score.
  • In the event that your interest rates increase with this option, will convenience be worth the extra monthly rates? 

Home Equity Loan or Line of Credit 

This route strictly applies to those of us who are homeowners. If you own a home, you might have the option of taking out a home equity loan. A home equity loan, otherwise known as a second mortgage, is when homeowners are able to borrow money using the equity in their homes. These are large loans with a fixed interest rate. 

Homeowners may also be able to fork out a line of credit on their equity. A homeowner line of credit (HELOC) functions similar to a credit card and has a variable interest rate. 

A couple of things to think about when considering a HELOC or a home equity loan:

  • The loans are secured by your house, which means that losing your home is a possible consequence of not staying up to date on your payments. 
  • HELOCs will typically necessitate that you make interest-only payments during the first 10 years. In this case, it would be wise to pay more than the minimum amount due to start carving away at your debt. 

401(k) Loan

You can also take a loan from your employer-sponsored retirement account, such as a 401(k) plan, but it might be best to consider this option a last resort if you are unable to get a different type of loan.

 The most obvious pitfall of taking out a 401(k) loan is that it can really make a dent in your retirement fund, but there are other obstacles too. If, for whatever reason, you are unable to pay back the loan, you will need to pay a large penalty. Borrowers usually have about five years to pay back their 401(k) loans, but if you quit your job or get fired, you’ll only have 60 days.

The silver lining: A 401(k) loan won’t be displayed on your credit report, meaning that it causes no harm to your credit score.  

If this sounds like a viable option for you, it’s important to be sure that you can pay it back. 

Debt Management Plans

A debt management plan is a debt repayment strategy that combines multiple debts into one monthly payment at a low interest rate. This is an option worth looking into if your credit score isn’t looking so hot. 

To qualify for a debt management plan through a credit counseling agency, you will need to have a regular income. Usually, these plans come with startup fees and/or monthly fees tacked on, and it will probably take anywhere from three to five years to pay it off. However, the monthly payments are fixed and your interest rate could be reduced by half. 

Tips for Getting Approved for a Credit Card Debt Consolidation Loan

If you are convinced that a credit card debt consolidation loan is the best choice for you, the next step is to do some planning. The proper preparation and forethought can mean the difference between getting approved and not.
Here are some tips you can follow to increase your chances of getting approved:

  1. Decide between secured and unsecured: 
    1. With a secured loan, you will need collateral, like your car or home. If your credit is isn’t exactly up to par, you might want to look into it, as secured loans tend to be more forgiving in terms of credit scores and interest rates. Nevertheless, you risk having your property compromised if you are unable to pay.
    2. An unsecure loan doesn’t require you to put anything up as collateral because it’s based off of your credit. Look into this if you have a decent credit score and save yourself the extra stress of putting your property at risk. Just be aware that interests rates on unsecured loans are sometimes higher.
  2. Figure out how much you will need to borrow: It’s in your best interest to add up all of the debts that you are hoping to consolidate. Though this isn’t necessarily a requirement, it’s helpful to know this in order to shop for the right lender. This way, you won’t have to worry about asking for too much or too little.
  3. Familiarize yourself with your credit report and score: Knowing where you stand in terms of your credit will save you a lot of time once you’re ready to start applying. The best loan options for your situation are largely dependent on how your credit is doing. 
  4. Shop for the best lender:  Just as we discussed above in our “How-to” section, financial lenders aren’t one in the same. There are pros and cons to each one and it’s important to choose one you feel comfortable with.
    Take your time and remember that it’s okay to pick your lender based off of how likely it is that you will get approved. Do your best research, read the fine print and then compare. 

Make a checklist: There are a lot of documents that you will need to gather in order to start the application process. To do this, you might need to get some information from your creditors and your employer so the earlier you start planning, the better.
Give yourself as much time as possible to get everything together.