Compare five solutions to find the best way to consolidate credit card debt in your situation.
No two debt problems are alike. While you and your neighbor may both be in debt, your financial situations can be very debt. So, the solution that works for them may not be the best choice for you. To find the right way to consolidate credit card debt, you must carefully consider your credit, budget and elimination goals.
What are the options to consolidate my debt?
Credit card debt consolidation refers to the process of taking multiple debts and rolling them into a single monthly payment. The goal is always the same: Lower or eliminate interest charges so you can pay off your debt faster.
There are four basic ways to do this:
- Use a balance transfer credit card to consolidate credit card balances onto one card
- Take out a low-interest personal debt consolidation loan to pay off your balances
- Tap available equity in your home using a home equity loan
- Borrow against your home equity with a Home Equity Line of Credit (HELOC)
- Enroll in a debt management program so a credit counselor can negotiate rates for you
All of them are viable options, but each works best in a specific set of financial circumstances.
Comparing 5 options for consolidation
Option 1: Balance transfer credit card
If you have an excellent credit score, this should be the first place you look to consolidate. Good credit means you can easily qualify for a balance transfer credit card. These cards offer 0% APR on balance transfers after you open the account. The introductory period can last from 6 to 24 months, depending on your credit.
A longer introductory period is better, because it gives you more time to pay off your debt interest-free. The goal is to eliminate the consolidated balances before the standard APR kicks in. So, you need to calculate carefully and make payments that are large enough to do this.
Option 2: Personal debt consolidation loan
This is an unsecured personal loan that you take out expressly for paying off your credit cards. If you have good credit, you can qualify for an interest rate below 10%; that’s generally the maximum rate you need to make this solution effective. A rate around 5% is ideal.
Once approved, the lender disburses the funds to your creditors, eliminating your balances in-full in one shot. Choosing a longer term reduces the monthly payment, meaning you can pay less and actually get out of debt faster. Just aim for a term that’s five years (60 payments) or less; otherwise, you may bump the total cost up higher than you’d want with too many rounds of interest charges.
Option 3: Home equity loan
If you’re a homeowner, you can borrow against the equity in your home. That’s the value of the home minus the remaining balance on your mortgage. In general, lenders allow you to borrow against up to 80% of your equity. So, if you have $100,000 in equity, you can borrow up to $80,000.
A home equity is a lump sum you receive all at once; it’s similar to the personal loan described above. The only difference is that in this case, you secure the loan with your home as collateral. This can lower your rate, but it also increases your risk of foreclosure.
Option 4: Home Equity Line of Credit (HELOC)
This solution is similar to Option 4, because you borrow against your home, using a Home Equity Line of Credit. However, in a HELOC, the lender basically gives you a credit line based on your equity. You can make withdrawals to pay off your credit cards and achieve other financial goals.
For the first 10 years with a HELOC, you make interest-only payments. At the end of the ten years, you must start repaying the balance you took out. These “balloon payments” can be a little tricky to manage if you’ve never done it.
Option 4: Debt management program
This is a form of assisted debt consolidation. If you don’t have good credit or have too much debt to consolidate on your own, this is the solution for you. You contact a certified credit counseling agency to enroll. They evaluate your finances to make sure this is the right solution, then help you enroll.
You work out a payment you can afford on your budget. Then the agency calls your creditors to start negotiating. They get the creditor’s approval for your enrollment, and negotiate to reduce or eliminate interest charges. These agencies have established relationships with creditors, so they can get better rates than you can get on your own. You make one payment to the agency and they pay your credits off accordingly.
|Balance Transfer Credit Card||Personal Consolidation Loan||Home Equity Loan||HELOC||Debt Management Program|
|Credit needed to qualify||Excellent is best||Good||Good-Fair||Good-Fair||Any, including bad|
|Monthly payments compared to what you pay now||Usually higher||Generally equal to or lower, depending on term||Generally equal to or lower||Lower at first; balloons after 10 years||30-50% reduction in total payments|
|Fees / added costs||$3 to 3% for each balance transferred||Usually none||Closing costs, similar to your 1st mortgage||May pay annual fees (typically $25-$75)||Setup and monthly fees; set by state, capped at $79|
|Risks?||Foreclosure risk for nonpayment||Foreclosure risk for nonpayment|
|Can I reconsolidate if this fails?||Yes||Yes||No||No||Yes|
Choosing the best way to consolidate credit card debt for you
Credit plays a primary role in determining which solution is best for consolidating debt. However, you also need to carefully consider the monthly payments that would be required to pay off what you owe.
For example, let’s say you consolidate with a balance transfer credit card with 0% APR for 24 months. You end up transferring $25,000 in total to pay off with a 3% balance transfer fee, which is fairly standard. That means you have $25,750 to repay, in total.
To pay off the balance before the 0% APR clock runs out, your monthly payments would need to be at least $1,073. That’s generally too high for most budgets.
By contrast, if you use a personal loan at 5% APR with a 5-year term, the payments are only $471.78. You can be debt-free in 60 payments. What’s more, on a regular minimum payment schedule, the monthly payments would be $500. You actually save a little cash, get out of debt faster and reduce your total costs. This would probably be the best way to consolidate in this situation.
If you don’t know for sure, ask a professional
Nonprofit credit counseling agencies exist to help people get out of debt. Even though they offer one potential solution, they’re legally prohibited from “driving” you to that choice. They MUST cover all the solutions available and let you know if there’s a better choice for your situation. So, you’re worried about running the numbers and comparing solutions on your own, contact a nonprofit certified credit counseling agency.
On home equity loans and HELOCs, the chart above shows that these options have an increased risk that the others don’t. If you fail to make payments, your lender can start the foreclosure process. Losing your home to pay off credit cards is generally just not worth it.
Even if the housing market is stable and your property value is steadily increasing, consider that a HELOC matures in 10 years. That’s a long time for our economy to take a nose dive. For instance, plenty of homeowners found themselves trapped in underwater mortgages for borrowing against equity during the Great Recession. The bottom can fall out, even if your finances are stable.
Make sure to check with a HUD-certified housing counselor before you tap your home equity. They can help you assess the risks to make sure you make the right choice. However, in general, if you have other options for consolidation open to you, choose those first.