Credit Card Debt Consolidation

Introduction

Depending on how you use them, credit cards can be powerful credit-building tools or sources of uncontrollable debt. 

Let’s say you’ve racked up some credit card balances. Suddenly you’re buried under an avalanche of debt that keeps growing, fueled by interest charges that never stop compounding. You feel like you could dig your way out and find the light. But just when you think you’re driving a bulldozer toward salvation, you realize you’re actually on a hamster wheel — always turning and spinning but never going anywhere.

Yes, it sounds like that stereotypical recurring nightmare. The one where you’re naked in the school hallway, you’re late to class, you’ve missed the whole year, you forgot to study for today’s final exam — and piles of books are falling from the ceiling, burying you alive while your feet are cemented to the floor.

OK, that might be a bit extreme — most people don’t dream about all those things at once. But it’s what dealing with credit card debt can feel like. So let’s stop spiraling and look at some potential solutions.

Debt Consolidation Options

Debt consolidation is when you combine multiple balances into one. This makes it easier to deal with for a couple of reasons.

1. You have fewer monthly payments — and in fact, you can often consolidate many payments into just one.

2. You potentially have lower interest rates after consolidation, meaning even though you’re still carrying a balance, it’s costing you less in the long run.

Depending on the size of your debt, how much you earn, and what credit score range you fall into, you’ll have a few options for credit card debt consolidation. And of course, each of them comes with pros and cons.

Making a Credit Card Balance Transfer

One of the most common and popular means of credit card debt consolidation is doing a balance transfer. However, it’s one of those things that people often spout off as being the answer, when the truth is it’s easier said than done.

You say, “I have too much credit card debt.” And your friend says, “Just do a balance transfer.” Or even worse, “Just get a 0% APR balance transfer card.” If this was a text thread, it would be time to cue the facepalm or eye-roll emoji. This advice is simplistic at best and condescending at worst.

A balance transfer involves moving your outstanding balance from one card (or several cards) to a new or different credit card. Ideally, you’re going from a high-interest card to a lower-interest card so you can save money. And ideally you’re working with a high credit limit so you can fit more of your debt onto that card. So your friend’s advice isn’t inherently wrong — it’s just extremely unrealistic for many people.

Here’s why. If you’re already buried in debt with maxed-out cards, the chances of qualifying for a new credit card with an introductory 0% APR offer and a high enough credit line to accommodate all your other debt is pretty slim. Just qualifying for enough credit would be challenging, but landing a 0% APR on top of that is more like walking into a Vegas casino and expecting to triple your money with a single roll of the dice.

However, despite the common myth, you don’t need a low-interest offer to complete a balance transfer. It might not make much sense to do a balance transfer when the receiving card has a high interest rate, but it’s usually possible.

Pros of a balance transfer

• You can theoretically reduce the number of payments you have to make each month.

• If you get a lower APR, you can save money on interest charges.

• You may be able to pay off your debt more quickly if it’s not snowballing as much.

• Your credit score could increase as a result of lowering your overall credit utilization ratio, which measures the proportion of your credit lines you’re using.

Cons of a balance transfer

• If you’re already carrying high balances, you don’t likely have room on your existing cards.

• It’s difficult to qualify for a new high-limit card when you’re already in debt.

• It can be almost impossible to get a low-interest APR when you’re carrying large balances on other cards.

• If you do find a low-APR offer, it’s usually only for a limited time before the rate goes back to normal.

• If you locate a good card that you may qualify for, the application is a hard credit inquiry — which could lower your credit score a bit.

Applying for a Debt Consolidation Loan

This is essentially the installment version of a balance transfer. Instead of moving your credit card debt to another revolving credit product, you’re taking out an installment loan. And you use the funds from the loan to pay the balances on all your credit cards, or as many as you can.

You could just use a standard personal loan to pay off your cards, but you’ll also find dedicated debt consolidation loans designed for this purpose.

Pros of a debt consolidation loan

• If the loan covers more than one card balance, you’re still reducing the number of payments you have to make each month.

• If the loan is enough to pay off all your cards, you can greatly simplify your finances.

• It may be easier to qualify for than a balance transfer card since it’s a different type of credit.

• The loan will potentially have a lower interest rate than the credit cards you’re consolidating.

Cons of a debt consolidation loan

• It’s still difficult to qualify if you’re already carrying a lot of debt.

• The interest rate is likely lower than your credit cards, but not always — or not by much.

• Applying for an unsecured loan is also a hard pull that may impact your credit score slightly.

Taking Out a Secured Loan

A debt consolidation loan, or any type of personal loan, requires good credit and ideal circumstances for the best terms and best results. If you can’t get approved for a regular unsecured loan, you still have a few options that leverage what you already own. These fall under the secured loan umbrella because you have to put up some type of collateral.

If you own a house, home equity loans or home equity lines of credit (HELOCs) are the most common solution here. These provide funds borrowed against your home’s equity, with the main difference being that a loan is paid off in installments and a line of credit is revolving. A home equity loan will also typically have a fixed interest rate applied to the whole lump sum, while a HELOC rate is usually variable and only on the portion you withdraw.

If you have a retirement account like a 401(k) — or a 403(b) if you work in public schools or the non-profit sector — you may be able to take a loan from that account as well. The way this works is you’re typically allowed to borrow up to 50% of your vested account balance (or $50,000, whichever is less). You then pay it back, often through direct payroll deductions, over a term of up to five years.

The interest rate is typically lower than a personal loan, and you pay that interest to yourself. But you lose some tax benefits in the meantime because you contributed pre-tax dollars, and yet you’re paying back after-tax dollars.

This is not the same as a hardship withdrawal, which does not need to be repaid but does have strict regulations. For example, it has to be for an “immediate and heavy financial need” in a specific category, such as medical or funeral expenses, tuition, or purchasing a primary residence. Debt consolidation does not usually qualify.

Pros of a secured loan

• You may not need as high a credit score to qualify for attractive terms since you’re backing it yourself.

• You can reduce all your credit card payments into one secured loan payment if you have enough collateral.

• Interest rates are likely lower than the credit cards, and potentially lower than unsecured loans.

• On some secured loans, like a 401(k) loan, you’re technically paying the interest to yourself rather than throwing it out the window.

Cons of a secured loan

• If you default on a secured loan, you may lose your collateral — which could be devastating if it’s your house.

• If you take out a 401(k) or 403(b) loan and leave that job, you may have to immediately pay the full balance or face an early withdrawal tax penalty.

• You pay back a 401(k) or 403(b) loan in after-tax dollars even though you contributed in pre-tax dollars.

• Taking money from your retirement account means you won’t be earning interest on that money while you repay it.

• Some retirement account loans prevent you from making more contributions until the loan is paid back in full.

• Your take-home pay is reduced when you’re making loan payments through payroll deduction.

Using a Credit Counseling Service

If your debt is so large that it’s overwhelming you, it might be time to consider some help. Credit counseling, or debt counseling, is a financial service that could be the answer. We’re not talking about the more aggressive debt settlement services here, although credit counseling could also lead to settled debts.

But before going down this road, it’s important to understand that not all credit counseling is created equal. You’ll want to look for a non-profit agency accredited by the National Foundation for Credit Counseling (NFCC) or the Financial Counseling Association of America (FCAA). And even then, weigh all the aspects before making a decision.

Pros of credit counseling

• You can learn financial literacy or budgeting strategies.

• You may get lower interest rates or simplified repayment plans.

Cons of credit counseling

• Comparing and evaluating programs to find the right one can be daunting.

• Some programs may negatively impact your credit score in the short term.

• Not all consumers qualify for credit counseling solutions.

Asking a Loved One for Help

If all else fails, you could borrow money from a relative or friend. Although it’s important to realize that this is one of those things you’ve been warned about your whole life, so only consider it if you’re sure it won’t go sideways.

Pros of family assistance

• It’s an informal agreement so you can set your own terms.

• If you run into issues paying it back, you can often get an extension or renegotiate.

Cons of family assistance

• Many relationships end up strained when borrowing money leads to never paying it back.

• That last point is worth repeating because life is too short to destroy your treasured relationships over money.

Bottom Line

Consolidating debt is usually a good thing, but how you get there requires some thought and insight. It’s tempting to take what seems like the easy route out of debt when you’re buried under that avalanche, but it’s not always the best solution.

Whether you decide to go for a balance transfer, take out a loan, put up your home or retirement fund as collateral, get counseling or ask a loved one, debt consolidation shouldn’t be taken lightly. It will affect your life for years to come — and only you can figure out whether that will be for better or for worse.