How to Consolidate Credit Card Debt
Americans owe almost $1 trillion in collective outstanding credit card debt, and the average credit card debt is $5,804. Managing credit card debt is even more complicated when your total debt is spread across multiple cards, each with a different interest rate and payment deadline. One solution to this problem is credit card consolidation.
What is credit card debt consolidation?
Credit card debt consolidation is the process of paying off debt from multiple credit cards using a single loan or credit card.
Having multiple credit cards with multiple balances can be intimidating — the more accounts you have, the easier it is to forget due dates and miss payments. Credit card debt consolidation offers a workable solution.
Consolidating your debt can also help you save money on interest payments if you get a lower interest rate on your new balance.
The top 7 ways to consolidate credit card debt
There are several options if you want to consolidate your credit card debt, though you may not qualify for some debt consolidation methods depending on your credit score and other factors.
1. Use a debt management program
A debt management plan is a program specifically for people struggling with multiple forms of debt. These plans, organized and run by non-profit credit counseling agencies, offer fixed monthly payments on your consolidated debt with lower interest rates. The organization negotiates with your creditors to lower your interest rate. You don’t have to take out a loan in a debt management program. Instead, you make one monthly payment on your debt to the non-profit agency, which then takes care of payments to your creditors.
The downside of these plans is that it can take up to five years to pay off your whole balance, and you may be subject to monthly fees. However, if you have a low credit score and don’t qualify for other credit card consolidation methods, a debt management plan may be the best way forward.
2. Take out a personal loan
People interested in consolidating their credit card debt often turn to personal loans as a solution. You can get a personal loan from a bank, credit union or online lender. Taking out unsecured personal loans — loans without any collateral like your home or vehicle — to consolidate debt may be difficult for people with fair or bad credit. If you have fair or bad credit, shop around at multiple lenders to find the lowest annual percentage rate you’re eligible for.
One advantage of consolidating credit card debt with a personal loan is that lenders have fixed interest rates for stable monthly payments. Since they generally have lower APRs than credit cards for those with good to excellent credit, a personal loan can help you save money and pay your debt off faster.
Certain credit inquiries, called hard inquiries, can bring down your credit score, but you can pre-qualify online for a personal consolidation loan through many online lenders without worrying about hurting your credit score. This will let you preview your rate, loan term and loan amount that you'll have access to after you formally apply. Keep in mind that these terms aren’t guaranteed;, they’re simply haestimates of what you might be approved for after a hard inquiry.
3. Borrow from your 401(k)
In some cases, you may be able to borrow from your employer-sponsored 401(k) plan to pay off your credit card balances. Loans from a 401(k) are generally due in five years, but if you quit or are laid off, the balance will be due on tax day the following year.
Since you’re borrowing from retirement funds, using a 401(k) loan to consolidate debt carries risk. If you can’t repay the loan, you’ll be subject to taxes on the unpaid balance and a penalty. Only consider a 401(k) loan if other credit card debt consolidation options aren’t available.
4. Tap into your home equity
If you’re a homeowner with significant home equity, another way to consolidate credit card debt is to take out a home equity loan to cover your outstanding balances. Home equity loans allow you to borrow against the equity in your home.Home equity is the difference between your property’s current market value and the amount remaining on your mortgage.
Home equity loans generally have lower interest rates than personal loans because your home serves as collateral. Just bear in mind that you can lose your house if you don’t meet the payments on a home equity loan.
5. Take out an auto equity loan
Similar to a home equity loan, an auto equity loan allows you to leverage the equity in a vehicle you own to consolidate your credit card debt. You take out a loan for your total credit card debt and put up your vehicle as collateral. The interest rate on an auto equity loan is generally much lower than the rate on an unsecured personal loan, thanks to this collateral.
The main limitation of an auto equity loan is that you can’t receive a loan for more than the vehicle's value. If your credit card debt exceeds your vehicle’s worth, an auto equity loan won’t allow you to pay off all your credit card debt. Additionally, the lender can repossess your car if you default on an auto equity loan.
6. Get a balance transfer credit card
Balance transfer credit cards allow you to transfer debt from other cards. They typically offer an introductory period during which the credit card company charges 0% APR on the amount transferred. You’ll have one year or more to pay off your consolidated balance without accruing interest. When the introductory period ends, the balance transfer card will charge you regular credit card interest rates on the remaining balance.
These cards typically charge one-time balance transfer fees (between 3% and 5% of the balance you consolidate), but with 0% APR, you will likely still save money even after those fees. To check whether this is the case, calculate the amount of interest you’d save over time and compare it to the balance transfer fees on the card you choose. If you’ll save more, it’s worth paying the balance transfer fees.
There’s a caveat, however: Many balance transfer cards only accept applicants with good or excellent credit scores. If your score is fair to poor, you might find it difficult to qualify for one of these cards.
7. Turn to family and friends for a loan
If you have family or friends willing to lend you the funds to help pay off credit card debt, that can be a great option. Even if they charge you interest, a loan from someone you know will likely offer better interest rates than debt consolidation loans from professional lenders. You also won't have to worry about credit checks or damage to your credit score.
Be aware that taking a loan from a friend or family member comes with the risk of damaging your relationship with that person if you are unable to pay off the loan in full. Set clear terms and get a loan agreement in writing to avoid conflict down the line.
What you should do before consolidating your credit card debt
Don’t jump straight into credit card consolidation. It’s worth your while to take some steps to get the most out of the process. Before you consolidate your credit card debt, start with the following steps:
Understand why you're in debt
Debt consolidation won’t solve your credit card debt problem unless you understand how and why you ended up in debt in the first place. Take measures to find the root causes of your debt and make sure they won’t lead to the same problem again. If, for example, you were overspending and unable to pay off your credit card statements in full each month, consider looking over your statements to see where you can cut expenses going forward.
Once you understand why you’re in debt, you’ll be better equipped to manage your new consolidated balance and stay out of debt.
Make a budget
Creating a budget will help you track where your money goes and where you need to cut back. You only have a set amount of money to spend each month, and your budget will guide you, so you don’t spend any more than your monthly income.
To start a budget, consider your spending over the last few months. Categorize your expenditures into mandatory spending (essentials such as housing, food and transportation) and discretionary spending (fun stuff, like entertainment and restaurant meals). While you probably won’t want to eliminate all discretionary spending, this is where you have the most flexibility to cut back your expenses.
Your budget should allocate a set amount of money to each spending category: bills, entertainment, groceries and so on.
Weigh your options carefully
There’s more than one way to pay off credit card debt. The ideal strategy is the one that allows you to pay off your credit card debt fastest without putting your other goals, like retirement, at risk. Compare APRs, credit requirements, loan periods and other loan terms to find the best one for your situation.
Seek advice from a credit counselor
For personalized help deciding whether credit card debt consolidation is right for you, consider using free financial counseling services. Credit counselors can advise you on the best way to pay off credit card debt based on your situation and needs. You can also ask a credit counselor for tips on negotiating with debt collectors if your debt has gone to collections.
Does credit card debt consolidation affect your credit score?
At first, consolidating your credit card debt may cause your credit score to decrease, but don’t panic. This drop in your credit score should be short-term, and it can have several causes, such as:
- Hard inquiries: A hard inquiry is when lenders or other financial institutions pull your credit report when you apply for new credit. This allows them to review details like your debt-to-income ratio, total outstanding debt and payment history to decide if you’re eligible for a loan. Because most methods of credit card debt consolidation require you to apply for new credit and hard inquiries can decrease your credit score, expect your credit score to dip a little when you consolidate your debt.
- Lower average credit age: One factor that affects your credit score is the average age of your credit, with a higher average age increasing your credit score. Since you'll open a new account to consolidate your debt and reduce your average credit age, your credit score may decrease slightly. If you close credit cards, as may happen when you use a debt management plan, that will also bring down your average credit age and decrease your credit score.
On the plus side, credit card debt consolidation will help you raise your credit over time, despite the initial dip, as long as you pay on time. Your credit utilization ratio — the ratio of your outstanding balances to your total available credit — may go down when you consolidate your debt, increasing your credit score. If you close credit card accounts while consolidating your debt, however, this won’t be the case.
For some people, consolidating credit card debt can actually improve their payment history because they find it easier to manage one balance, especially with a lower interest rate. Payment history is the most important factor in your credit score, so consistently paying on time will raise your credit score. In other words, debt consolidation may initially hurt your credit score, but it can ultimately boost your credit score as long as you make payments on time.
Summary of how to consolidate credit card debt
Credit card debt consolidation has pros and cons as a strategy for paying off credit card debt. In general, consolidating your credit card debt is a good idea if you can get a lower interest rate on your consolidated balance than you were paying on average across your credit cards. The lower interest rate means your monthly payment will be lower, helping you to pay off your credit card debt faster.
There are a number of options for consolidating multiple outstanding credit card debts, including using your home equity to borrow via a home equity loan, taking out an auto equity loan, borrowing from your 401(k) or from family and friends or working with an agency that helps people with debt management.
Before making a decision, weigh all the pros and cons of the various options. Consider how your credit score could be a factor, the interest rates on your current debts, any fees associated with consolidation and your ability to make payments on time.