What Is Credit Card Consolidation?
So, you’ve over-succumbed to the siren song of American consumerism. Don’t beat yourself up; those Mad Men (and Women) remain magnificent at marketing pricey lifestyle dreams.
But now you have bigger credit card bills than you can manage.
You’ve heard about credit card consolidation — or, more accurately, credit card debt consolidation — but you’re not sure what’s involved, or whether it’s for you.
What is it? How does it work? What are the benefits? What are the pitfalls? Does one size fit all? Or is every situation distinct? If the latter, how can I know my best consolidation fit?
So many questions. But we’ll start with this one: What is credit card consolidation?
Credit card consolidation is any method of combining multiple credit card payments into one single consolidated monthly payment.
Consumers consolidate debt for a lot of reasons, but mainly to reduce their interest rate; lower their payment; get out of debt months, perhaps years sooner; and to stop calls from collection agencies.
1. Debt Management
This might be the easiest, least intrusive method for consolidation, though it does require the discipline of paying on-time, which sometimes is lacking among people in debt.
So, why is it at the top of the list?
Simple: If you legitimately are in a crisis, credit card debt consolidation that involves an intervention – with free help from certified credit counselors – can steady your financial boat.
Debt management is offered by nonprofit credit counseling agencies like InCharge Debt Solutions. The agencies are accredited by the National Foundation for Credit Counseling, whose goal is to provide a solution for your problem, educate you on the causes and show you how to avoid them in the future.
WHO IT’S BEST FOR: Debt management works for consumers who haven’t managed their money well enough to keep up with expenses. In other words, they make enough money to handle their debts, but either don’t have a budget or don’t stay on track with their budget.
Credit counseling also benefits borrowers who at last have concluded they could use the guidance and wisdom of a professional financial service to get their house in order.
- Reduced interest rates – usually 8% or lower – on their debt.
- A single, lower monthly payment.
- The support of a company expert to negotiate debt relief with your card companies, and help clients meet — and abide by — their new obligations.
- No heavy lifting. The credit-counseling company does the work with card companies to make monthly payments affordable, without crippling the consumer’s budget.
- You know exactly when your credit card debt will be paid off. If you want to pay it off early? No problem!
- Contacts from debt collectors ends.
- There is a modest set-up fee, as well as a monthly service fee.
- Many credit-counseling agencies require clients to close most, if not all, of their credit card accounts.
- Because credit scores are influenced by the amount of credit available, the client’s rating may take a hit the first six months or so.
BOTTOM LINE: This is the least risky method of credit card debt consolidation … by far! If you qualify, the credit counselor is telling you that you have enough income to pay off your debts. Just manage your money better! Canceling all your credit cards is a good thing. That’s how you got in trouble. You don’t need to take out a loan. And if it doesn’t work out for any reason, you can withdraw from the program at any time with no penalty. That’s not the case with any other option.
2. Credit Card Refinancing
In credit card refinancing, borrowers take on a new credit card that features 0% interest and use it to pay off a card, or cards that feature 15%-30% interest.
Qualifying isn’t easy … and the 0% interest rate expires over a set timetable … and there could be a transfer fee to pay … and did we mention that the 0% interest expires?
WHO IT’S BEST FOR: Borrowers with a relatively small amount of credit card debt — an amount they can pay off during the period of the “teaser” rate (usually 12-18 months) — are the best candidates.
- You get to consolidate credit card debt at zero-percent interest and you can’t possibly beat that.
- If you’re a fan of the “debt avalanche” method — that is, you attack, in turn, the credit card balances with the highest interest rate — you’ll love the credit card refinancing method. Consider the consumer who transfers a $7,000 balance at an 18% APR to a card with a zero-percent APR for 12 months. By paying off the balance during the teaser-rate period, the borrower saves $701 in interest.
- Consumers need fairly good credit scores to qualify (at least 670 or higher) to get the zero-percent rate as well as the highest credit limits.
- Most zero-interest cards come with balance-transfer fees of 2%-3%. Run the numbers to make certain you’ll come out ahead at the end of the introductory period.
- If you don’t pay off the balance in the teaser-rate time period, you will start paying at a very high interest rate, somewhere around 20%.
- Your credit score likely will take a hit because you have applied for another card. Also, unless you get a huge raise in your credit limit, you probably will take on more than the 30% balance limit recommended for one card.
BOTTOM LINE: This is a tough one because 0% interest is a great deal, but will you have the credit score needed to qualify? Also, the fine print tends to be merciless. Payment late? So long, introductory rate. (Better automate that payment!)
3. Personal Loan
This method could not be more straightforward: Add up the outstanding credit card debt you want to consolidate and go shopping for a loan that will pay it all off at once.
Check banks (it doesn’t have to be the one where you have your checking and savings accounts), credit unions (ditto), and online/peer-to-peer lenders, such as Upstart, Funding Circle, Prosper Marketplace, or CircleBack Lending (to name four; there are dozens more).
When your loan is funded — ideally at a significantly lower APR than the average of your credit card balances — you use the loan to zero out each of your credit card accounts, while keeping them open. Having all that available credit — which you are NOT going to touch — looks good to the Big Three credit reporting agencies: Experian, Transunion, Equifax.
Cut up your cards if you must. Feed them through a shredder. Save one in the freezer in a block of ice, in case you need to reserve a hotel room, or rent a car.
WHO IT’S BEST FOR: Borrowers with substantial credit card balances and daunting APRs could find relief, especially if they have few, if any, assets they can borrow against.
Naturally, the better credit the borrower has, the better deal (lower APR, higher loan amount) your likely to secure.
- The combination of a lower APR and, conceivably, a longer repayment period should produce a lower overall monthly payment.
- Speaking of repayment periods, the life of a personal loan is fixed. Unlike balances on revolving credit cards, the borrower knows when the consolidation loan will be paid off.
- Most personal loans are unsecured, meaning you don’t need to risk collateral behind it.
- Borrowers with damaged credit are certain to get saddled with comparatively higher interest rates and less generous loan amounts.
- Personal loans often come with origination fees and other closing costs. Scrutinize those to make certain you’re not trading one crushing debt load for another.
BOTTOM LINE: If you like this idea, be sure you’re committed to making all payments on time. With a consolidation loan, you’ll be out there on your own. Without a workable strategy to keep your spending under control — and discipline to see it through — you could succumb to the wily ways of advertisers whose jobs depend on getting you to Buy! This! Shiny! New! Thing! Now!
4. Borrow from Assets
Do you make mortgage payments or fund a 401k retirement program? Either one could be enough of an asset to help you successfully consolidate your credit card debt.
Owning your own home gives you access to a home equity loan. You also can borrow against the accumulated assets in your 401k retirement plan and use them to retire credit card debt.
Both involve risk because you’re putting assets in danger, but done properly, they also could help you plug the hole created by credit card debt.
Home Equity Loan
This is borrowing against equity (market value minus amount still owed) you’ve built in your home. For example, if you’re home’s market value is $200,000 and you owe $150,000, you have $50,000 worth of “equity” in the home.
Lenders typically allow you to borrow 80% of that equity (in this example, $40,000) and pay it back at interest rates that should be far less than what you’re paying on credit cards. The average interest rate on credit cards in the summer of 2019 was 16.9%. The average rate for home equity loans was around 5%-8%, depending on your credit score.
WHO IT’S BEST FOR: Someone with a high amount of credit card debt, a large amount of equity to borrow from and a credit score of 670 or higher.
- Chance to eliminate all credit card debt in one fell swoop.
- Fixed monthly payment and time frame (usually 5-10 years) for repaying the loan.
- Should result in far lower interest rate than credit cards.
- Lower interest rates also should mean lower monthly payment.
- You’re putting your home at stake. If you miss payments, you could be foreclosed on.
- There are fees – application, origination, appraisal, documents – for most home equity loans.
- If property values decline, you could be underwater with this loan.
BOTTOM LINE: A home equity loan should be a safe, predictable, affordable method of credit card consolidation, provided you make your payments every time. However, consider this: The debt from your credit cards was a loan and you didn’t repay that. Putting your house at stake to take out another loan to retire ones you already couldn’t pay off, is risky.
Almost all companies that offer a 401(k) retirement plan, allow vested employees to borrow against the money in that plan.
Basically, you are borrowing from yourself and repaying yourself with interest. However, it’s not as simple as taking money from one pocket and putting it another. There are restrictions, rules and guidelines for borrowing and penalties involved if you don’t follow them.
WHO IT’S BEST FOR: If your credit score is not high enough to get a low interest rate, this is a good alternative. It’s also a good idea if your goal is to quickly eliminate high-interest rate debt from credit cards – and you promise not to get into the problem again.
However, as you will see in the “Cons” section below, there is considerable risk involved if you stumble again financially and miss even one monthly repayment.
- The interest you pay on this loan goes back to you.
- You are borrowing from yourself, so no credit check is needed and your credit score has no influence on the loan.
- In most cases, you can repay the loan through payroll deductions.
- It’s possible you could eliminate all credit card debt at one time.
- The interest rate varies, but usually is 1% or 2% above prime, which was 5% in 2019.
- The most you can borrow is 50% of your account balance or $50,000, whichever is less.
- If you miss a payment, and are under the age of 59 ½, you must pay taxes on the amount withdrawn and a 10% penalty for early withdrawal.
- Some plans don’t allow contributions until you finish repaying the loan, which could mean a hit on your retirement savings if you take more than 1-2 years to pay it back.
- Your account misses out on returns it would have earned, had you not taken out a loan.
- If you leave your job and haven’t finished repaying the 401(k) loan, you must pay it off by the tax return due date for that tax year. In other words, if you leave in 2019, you must pay it off by April of 2020.
BOTTOM LINE: The 401(k) plan was not meant to be a saving account or emergency fund that you can tap anytime you need it. However, if you have considerable high-interest credit card debt, a 401(k) loan a simple way to address it. Still, most experts advise against using this method, unless all other avenues are blocked.
5. Debt Settlement
Debt settlement is, by far, the most tempting and controversial option for consolidating credit card debt. You receive short-term debt relief in exchange for long-term credit penalties.
In a nutshell, debt settlement is paying less – they claim as much as 50% less – than what you owe to settle your account. It involves a protracted negotiation process (2-3 years), in which the lender is offered a lump-sum payment in exchange for forgiving the balance of your debt.
You can attempt negotiations yourself, but typically a third-party company or lawyer represents you and charges a fee.
WHO IT’S BEST FOR: Debt settlement is for consumers whose accounts have been sold to debt collection agencies or for those who saved enough money to make a lump-sum offer the lender or collection agency will accept.
If you have defaulted on your credit cards – no payment for 180 days or more – this may be the only option you can consider, other than bankruptcy.
- There is a chance you will save money.
- It’s possible you could settle your debt quicker, if you have a lump-sum payment ready to offer.
- You could negotiate a settlement yourself.
- You won’t have to declare bankruptcy.
- It’s possible you end up with more debt than you started. The balance will grow quickly because of monthly late-fee penalties and interest on your account while you gather enough money to make the “lump-sum” offer.
- If you hire a debt settlement company, their service fees often wipe out whatever balance you had forgiven. Your net gain may be no more than 20%.
- “Debt Settled” will appear on your credit report for seven years, telling future lenders that you did not make full payment on your debts.
- Your credit score will drop anywhere from 50 to 150 points. Rebuilding your credit score likely will take years, something to consider if you plan to get a mortgage or car loan in the future.
- Lenders aren’t obligated to accept settlement offers. Some won’t even entertain the idea.
- You likely will have to deal with a collection agency to resolve the debt.
- You may have to pay taxes on whatever amount of debt is forgiven.
BOTTOM LINE: Debt settlement is the last step before declaring bankruptcy and is a far harsher choice than the advertisements let on. By the time you finish with the lump-sum payment, the service and late payment fees, plus interest charges on your balance, you may barely be above break even. This does work in some situations, but be careful. Bankruptcy might even be a better option.