How To Consolidate Credit Card Debt

Last Updated: October 24, 2017 in Credit Cards • 

A practical way to help you get out of debt faster is to consolidate your credit card debt. You can:

  • Obtain a loan for the total amount due on all your credit cards
  • Pay off your individual credit card debt with the funds from this loan and a lower interest rate.
  • Use your savings, to begin to pay off the loan principal faster and save the money that you would have wasted on interest payments, late fees or other charges.

This process is called, “debt consolidation.” You combine all your credit card debt into one lump-sum loan and pay only one bill instead of several individual credit-card bills each month. While it may seem a bit counter-intuitive, combining all your debt into one loan and making one payment works for several reasons:

  1. You’ll pay less in interest. Because each credit card or loan on which you are paying has its own interest rate and penalty charges. When you add up these individual payments, they will total more than what you would pay in a consolidated loan.
  2. You’ll pay less in penalties. If you happen to miss a payment or can’t pay the minimum amount due, the credit card company will charge a fee for either or both. If this happens on more than one card, the extra fees, charges and penalties in total will be more than a single payment on the principle and interest for a combined loan.
  3. You'll miss fewer payments. Missing payments and making less than full monthly payments on individual credit cards are expensive and costly mistakes. The penalties that the credit card companies charge increase the balance. Additionally, all credit card companies will increase your interest rate. Both actions increase your financial burden and the time it will take you to pay off the balances.
  4. You'll lower your interest rate. Consolidation loans usually have a lower interest rate than what you are paying on any of the individual credit cards. You will save a significant amount of money each month with a lower interest-rate obligation.
  5. You will save time. Normally, you would make payments to several credit card companies, home equity loan providers, and other creditors. When you consolidate, you will have to write only one check each month.
  6. You will lower your debt-in-use ratio. Credit bureaus look at the balance you keep on each credit card in relation to the amount of credit that the credit card company is extending to you: much credit you are using versus how much you have available. If this ratio is too high, paying off the total amount of credit you are using on individual cards eliminates the negative effect on your credit rating.
  7. You'll improve your credit score an average of 20 points within just three months of paying off debt with a consolidation loan. Eliminating debt is the best way to increase your credit score. A loan does not eliminate your debt but it eliminates the balance on individual cards. Consolidation loans make it easier to pay the balance off sooner.

There are a few different ways to consolidate credit card debt into one loan. You may take a personal loan, a home equity line of credit or transfer your credit card balances to one, lower-rate credit card. Which method is best, depends on your personal situation.

Personal Loans

Within the last few years, several new, consolidation-loan companies have entered the market making it easier than before to obtain a loan. Interest rates have remained relatively low as well. Many lenders will let you make an application without reporting it to the credit rating companies.

Simply applying for credit in any form, can negatively affect your credit rating. With everything online now, it is easy to apply from the privacy of your home and without feeling ashamed or embarrassed to make an application. Compare the terms of loans that have both variable rates and fixed rates and obtain a full list of the fees and costs associated with the application and opening an account.

Home Equity Loans and Lines of Credit

If you own a home, you can use the equity in your home as security against the loan. This was a popular way of consolidating debt before the financial crisis of 2008. Home equity loans typically have a lower interest rate than unsecured loans and credit cards. Credit unions typically offer a lower interest rate than banks do.

The interest you pay on the outstanding balance is deductible on your federal income taxes. The downside is that if you fail to make payments for any reason, the lender can try to foreclose on your home-equity loan in order to recover the money the lent to you. You could lose your home in extreme cases.

Balance Transfers to Other Credit Cards

While not as often as in the past, many credit card companies will offer a 0% interest rate on the credit card balances that you transfer to their cards. Generally, only people with already-excellent credit scores and low debt will even receive these offers. However, there are some programs available to people with mid-range credit scores.

Debt-Management Companies

These companies may or may not be helpful to you. It’s a good idea to do a lot of research on any that make tempting offers to you to consolidate your credit card debt. They are not extending a consolidation loan to you. Rather, you will be paying them while they withhold your payments to the credit card companies as leverage for negotiating a lower settlement amount.

It’s important to note that they are not paying off your debts. Rather, they are trying to force the credit card company to write off your account or settle for a lower amount. In the meantime, your credit rating suffers because you are not paying on your debt. The negative information will stay on your credit report for seven years.

Non-profit consumer credit counselors may be a better resource for you if you are struggling with credit card debt. These counselors can help you avoid the temptation to run up your credit cards with debt again after you’ve just paid them off with a consolidation loan.

Eliminate High Interest Debt With a Consolidation Loan

Debt consolidation works if you understand that the debt is still there, you are just paying less in interest while you pay it down. You also need to change the habits that caused the excessive debt-accumulation in the first place. Understand how to avoid incurring debt that you can’t afford to repay. Working with a counselor can help you identify the spending habits that you should change as you rebuild your credit for the future.