What Credit Card Debt Consolidation Means for You

The best solution for you may be credit card debt consolidation. If you’ve never heard of it before, consolidation may sound complicated. But it’s less scary than you think, and it can help you rescue your credit score before it’s too late.

Basically, you combine all of your credit card debt so you only have one monthly payment and a lower interest rate. You can do this with a personal loan, a debt management program, a balance transfer credit card, or a home equity loan.
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Decide if credit card debt consolidation is right for you

Looking for relief from high interest rate credit card debt? Credit card debt consolidation could be the answer you need. Credit card debt has a way of causing problems for your finances. Other debts like loans have fixed payments that you can plan around in your budget. But with credit cards, the monthly bills on credit cards vary based on how much you owe.

In some cases, this means you must pay the whole balance off every month (like with American Express cards); these are known as charge cards. In most other cases with general-purpose credit cards like Visa and MasterCard, you pay a percentage of the balance owed. This is also how most high-interest store credit cards work. But in all cases, you can’t always plan ahead for how much income your credit card payments will use each month.

As a result, when you overcharge or rely too much on credit, your bills can get out of control and start to take over your budget. You pay more and more, but never seem to get anywhere. That’s because even with average credit card APR, interest charges eat up more than half of every payment you make. So, even though you meet the minimum payments month after month, you don’t get any closer to zero.

This is where credit card debt consolidation comes in handy, because you reign in those high payments and simplify them into one low payment instead. There are several ways to accomplish this goal. Choosing the right credit consolidation option depends on:

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The benefits of debt consolidation

The biggest benefit of any credit card consolidation option is that you make a plan that helps you eliminate debt quickly so you can pay off your debt in full. This helps you avoid credit score damage. It can even help you build credit as you reduce debt and build a positive credit history.

This is one advantage that consolidation provides over debt settlement. Settlement programs may help you become debt free faster, but they are guaranteed to hurt your credit. If you care about credit damage, then consolidation is usually the better choice.

The second benefit of consolidation is how much money you can save. High interest means your debt grows faster each month with more interest added. On a high interest rate credit card, your debt actually cost more money. If you reduce the interest rate, it will save you money as you pay off debt.

This is especially important for high-rate credit cards. Reward credit cards and store cards often have rates above 20% APR. More than two-thirds of each payment covers accrued interest charges. Plus, on a minimum payment schedule, you can end up paying more in interest charges than the amount you originally charged to the card.

This is why consolidation often offers the benefit of getting you out of debt faster even though you pay less each month. This is most commonly seen with debt consolidation loans and debt management programs. Statistics show that the average debt management program client sees their total monthly payments reduced by up to 30-50%.

Finally, debt consolidation simplifies your life by streamlining your monthly debt payments. Instead of worrying about keeping up with multiple bills, you only have one payment to worry about. You can stop juggling bills and putting off expenses that you can’t afford to cover that month.

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The risks of debt consolidation

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4 ways to consolidate credit card debt

There’s more than one way to consolidate – in fact, there are four. We’ve put together the following chart to help you understand each of the four options.

Unsecured personal debt consolidation loans

To use this solution, you take out an unsecured personal loan (a loan without collateral). You use the money you receive from the loan to pay off your credit cards and other debts. Once executed, the only debt you have to pay off is the loan, itself. This consolidation option offers the benefit of fixed monthly payments.

The costs to use this option are also relatively low; you usually only need to pay a loan origination fee, although some lenders may waive them. Other than that, the only cost is the applied interest charges. With good credit, you can usually qualify for a low rate, particularly compared to the relatively high rates on credit cards.

Debt management program

A debt management program is essentially a professionally assisted form of debt consolidation. You enroll in the program through a credit counseling agency. With this option, you still owe your original creditors and you don’t take out any new financing. The credit counseling team basically acts as a go-between to set up a repayment plan that works for you and your creditors. They also negotiate on your behalf to reduce or eliminate interest charges and stop future penalties.

Once the plan is set up, you make one monthly payment to the credit counseling agency. Then they distribute it to your creditors. Your credit card accounts are frozen, so you can’t make new charges while you are enrolled. The cost of setting up a debt management program varies by state and depends on your budget. But, by law, fees are capped everywhere at $79.

If you can’t qualify to consolidate debt on your own and/or don’t want to borrow against your home, a debt management program is usually your best option.

Credit card balance transfer

With balance transfers, you move the balances from your existing credit cards to a new balance transfer credit card. If you have a good credit score, these cards offer 0% APR promotion periods when you first open the account. Promotion periods range from 6-24 months, depending on your score. Ideally, with excellent credit, you can qualify for 0% APR for up to 48 months. That gives you two years (24 payments) to focus solely on paying off principal interest-free.

Be aware there may also be fees associated with transferring your balances; understand these fees before you apply. Fees generally range from $3 to 3% of each balance transferred.

Home equity loan

This is a secured version of the loan described above. If you can’t qualify for the low interest you need without collateral, you may be able to borrow against the equity in your home. This allows you to qualify for lower interest rates, even with a weaker credit score. If you take out a home equity loan, you enjoy fixed monthly payments, just like you do with unsecured loans.

There’s also an open-end credit line version of this loan called a Home Equity Line of Credit (HELOC). In this case, you qualify for a credit limit based on your equity that you can withdraw money from as needed. You pay interest-only for 10 years, then start paying principal plus interest. As a result, your payments increase significantly after 10 years.

Be aware that borrowing against your equity to pay off credit card debt is the highest risk option! If something happens and you can’t make the payments, you can put yourself at risk of foreclosure. This is why experts often recommend that you should tap equity solely for the purpose of paying off credit card debt. You effectively convert unsecured debt to secured. The cost savings is rarely worth the increased risk.

Still, if you plan on using a home equity loan or HELOC for other purposes, such as a home renovation project, you can use some of the funds to pay off a few credit card balances. But always consider your options carefully and understand the risks before you decide to touch the equity you have built up in your biggest asset.

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Does consolidating debt affect your credit score?

Delinquent accounts negatively affect your credit report. They will be removed after 7 years if you ignore them, but until then, they can wreak havoc on your credit score and make it difficult to get a loan you may need for a large purchase. Your whole life can be slowed down by debt on your credit report.

Credit card debt consolidation can help you improve your credit score because you are, slowly but surely, paying off the debt that’s damaging the report. At first, your score will take a hit. You can’t expect your report to improve overnight. But eventually, your score will rise as you pay off your debt.

The short answer: It depends.

In some cases, debt consolidation can help your credit score. But in other cases, it can hurt your score. It can also depend on which option you use for consolidation, since there’s more than one way to consolidate your debt.

When debt consolidation helps your score

For the most part, if you use the right option for debt consolidation for your circumstances, it shouldn’t hurt your credit score. In fact, most times your score will improve.

Why?

When you consolidate debt, you have a payment plan that you’re supposed to follow. If you follow that plan correctly, this means you’re making payments on time and taking steps to cut your debt load. Those are the two biggest factors in determining your credit score. So many times, your score goes up as your debt goes down.

When debt consolidation hurts your score

Debt consolidation usually only hurts your credit score when you don’t do it right or don’t use the right solution – that includes a debt management program!

So how and when does that happen?

When you start a debt management program, you’re adjusting the payment schedule for your credit cards. So it’s important to note that your creditors may report that you’ve missed a payment on your credit reports in the first month your plan starts. Basically, this happens because there can be a gap between when payment was supposed to be made on your previous payment schedule and the payments you’re making now.

This only happens in the first month of the program. After that, your payments are made on time according to the new schedule. As a result, most people see their scores improve because they have low credit scores starting out. That one month of “missed” payments is usually a drop in the bucket compared to all the other payments that might have been late or missed while you were struggling.

Of course, if you have really excellent credit, then a few missed payments in the first month of your debt management program CAN make a difference and lower your scores. But really, if your credit is that high you’d be better off consolidating on your own with a debt consolidation loan or credit card balance transfer.

Can a balance transfer or consolidation loan hurt my score?

If you don’t pay the debt off responsibly, yes. Any time you miss a payment, you hurt your credit score. So if you consolidate your debt by transferring credit card balances or by taking out a personal unsecured consolidation loan, you shouldn’t have any credit damage unless you miss a payment.

Unfortunately, some people get into bigger trouble with debt after they consolidate. Why? Because once the debt is consolidated, you’ll have zero balances on all of your credit cards. It can be really tempting to start going out and spending before you pay off the consolidated debt. This is just making your debt problems worse.

Always finish paying off consolidated debt before you start charging again. Otherwise, you can have a real mess on your hands and can ruin your credit in the process.

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How credit card debt consolidation works

Credit card debt consolidation combines multiple debts into one payment at the lowest interest rate possible. There are several ways to do this.

What can you consolidate?

That’s not to say that other debts can’t be included in your credit card debt consolidation plan. With most solutions, you can consolidate other types of unsecured debt. This includes:

• Credit cards
• Store cards
• Charge cards
• Unsecured personal loans
• Unpaid medical bills
• Debts in collection
• Payday loans

Understanding the goals of consolidation

With credit card debt consolidation, all these unsecured debts are rolled into one payment. You have two goals when you consolidate your debt:

1. Simplify and lower your total monthly payments.
2. Reduce the interest rates applied to your debt.

The first part makes it easier to manage debt in your budget. You only have one bill to worry about. And depending on which consolidation option you choose, you may even have fixed monthly payments. That can make it easier to plan ahead for debt repayment than the typical revolving payments you see with credit cards.

As for reducing your interest rates, the goal is to get the monthly interest charges down as low as possible. This allows you to focus on paying off the actual debt (principal), rather than just the accrued interest charges. Since more of each payment goes to eliminating principal, you can often get out of faster even though you may pay less each month.

No matter which solution you decide to use, your goal should be to achieve an interest rate that’s no higher than 11 percent. Ideally, you want the interest to be even less than that. If the interest rate is any higher, you won’t get the benefits you need to pay off the debt quickly.

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Making sure you choose the best option for credit card debt consolidation

Every financial situation is different. So, the solution that worked for a friend or neighbor may not always work for you. What’s more, choosing the wrong solution can make your situation worse, instead of better. So, you need to choose carefully.

• If you don’t have a good credit score, don’t bother with balance transfers and consolidation loans.
• You generally want to avoid using home equity unless:
  • You have other reasons to tap your equity and paying off credit card debt is simply a secondary purpose.
  • You’re certain that you will not encounter any challenges meeting the payments; otherwise, you risk foreclosure.
• If you use a balance transfer, you should be able to pay off the full balance before the 0% APR period ends.
• Most debt consolidation loans have a term of 4-5 years (48-60 payments); the monthly payments depend on the loan term and how much you owe; thus, this usually only works if you owe less than $35,000, depending on your income.
• Finally, if you have a bad credit habit, DIY solutions are risky! They eliminate your balances and don’t freeze the accounts. That means you can start charging again immediately after you consolidate. You end up with more debt, instead of less.

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The bottom line

Is credit card debt consolidation the right debt relief solution for you? That all depends on your situation. The information here is meant to give you a new perspective on consolidation and what it means for your financial future, not tell you what to do. Everyone’s situation is different and it’s important to understand your unique financial position before taking action.

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