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Using a Credit Card Debt Consolidation Loan

Using a personal loan to consolidate credit card debt can be effective, but you need the right strategy and the right terms.

Use a credit card debt consolidation loan to squeeze debts into a single paymentHigh interest rate credit card debt can be tough to pay off efficiently. As your balances go up, minimum payments barely make a debt. Even if you put extra money towards the debt, it can take years to pay back what you owe. In the meantime, interest charges pile up, increasing your total cost. A credit card debt consolidation loan allows you to consolidate on your own. You can even save money, even though you may pay less each month.

What is a debt consolidation loan?

A consolidation loan refers to financing that you take out in order to consolidate a specific type of debt. In general, you can only combine similar types of debt with a single loan. So, a loan to consolidate unsecured debt would be different from, say, a Federal Direct Consolidation Loan for student debt.

In this case, you use a personal loan to pay off your credit cards and other unsecured debt. That refers to any financing that doesn’t require collateral. It includes:

  1. Credit cards
  2. Store cards
  3. Gas cards
  4. Payday loans
  5. Unsecured personal loans
  6. Unpaid medical bills

How to pay off credit cards with a personal loan

  1. You apply for a loan that’s big enough to cover all the unsecured debts you have from the list above.
  2. The lender will determine if you get approved based on your credit score and debt-to-income (DTI) ratio.
  3. Once you receive approval, the money is disbursed. Depending on your DTI, the lender will either give you the funds or send them directly to your creditors.
  4. The funds pay off your other unsecured debts, leaving only the loan to pay off.

3 Traps to Avoid with Credit Card Debt Consolidation Loans

#1: Don’t be surprised if the lender requires direct disbursement

Anytime you apply for a traditional loan through a lender, they look at your debt-to-income ratio during underwriting. You must have a DTI of 41% to get approved. With consolidation, people are often already close to that threshold. In many cases, taking on this extra loan puts you over that limit.

However, lenders understand that you want to use the funds you receive to pay off other debts. Even though your DTI is over 41% with the consolidation loan, it might be under once you pay your creditors. If that’s the case, you can get approved, but only with direct disbursement.

This means that instead of giving the funds to you, the lender sends the funds directly to your creditors. You tell them how much you owe each credit issuer and they distribute the funds accordingly.

#2: Stay away from secured debt consolidation

The loan we’re talking about in this article is an unsecured loan. However, if you’re a homeowner you can also take out a secured loan to pay off credit card debt. You do this by getting a home equity loan. This is where you borrow against the value built up in your home.

Home equity loans aren’t exactly bad, but they’re usually not the right choice for paying off credit card debt. The main reason is that you effectively convert unsecured debt into secured debt. You increase your risk by consolidating, and that’s not a good thing.

Most credit cards are unsecured debts. That means that as much as a collector might threaten, they can’t actually take your property without a court order. They have to sue you in civil court in order to recoup any losses if you fail to pay what you owe.

By contrast, a home equity loan is secured using your home as collateral. Fall behind on the payments means you risk foreclosure. Creating that kind of risk is usually not worth it just to pay off your credit cards, particularly when you have other options.

#3: Watch out for zombie interest charges on your next bill

Credit card APR works in some weird ways. That works in your favor if you pay your debts in-full every month because you can avoid interest charges. If you start and end a billing cycle with a zero balance, APR doesn’t apply.

However, if you have balances that you carry, many creditors apply APR to something they call your “average daily balance.” They basically average out your debt over the billing cycle. But that means you can wind up with interest charges on your next bill even if the balance was paid-in-full.

For instance, if the creditor receives the disbursement in the middle of the billing cycle, you may see interest charges on your next bill. They can even be significant, depending on how high your balance was when you started the month. And it’s frustrating, because you are under the impression that you paid off your debt. Yet, here’s another bill.

Don’t worry! In most cases, you can simply call the customer service line to negotiate to have those charges removed. Creditors want to keep your business. They want you to use their card. So, if you paid in-full, point out that you’re working diligently to pay your debt and didn’t expect to get a bill. They’ll usually waive the added charges.