Should You Consolidate Your Credit Card Debt? The Complete Guide

credit card debt consolidation

By Donna Freedman

It can be far too easy to get into credit card debt, and incredibly hard to get out of it.

Whether the reason is careless spending habits or something that’s out of your control (illness, job loss), credit card debt consolidation might be an answer.

Is it the right answer? That depends.

Despite what those late-night TV ads or Internet pop-ups say, credit card debt consolidation could potentially make your finances worse. Done right, though, it might be a chance to get back on track.

Credit card debt consolidation is a highly personal decision. Here’s what you need to know to decide whether it’s right for you.

In this article

What happens when you consolidate credit card debt?

“Consolidating” means paying off your cards with a loan, balance transfer or debt management program. Instead of paying multiple cards each month, you make a single payment.

Basically, you’re borrowing money to pay off money you previously borrowed.

What are your options for consolidating credit card debt?

There’s more than one way to consolidate credit card debt. The type(s) you consider depends on your personal situation.

Credit card consolidation loan

Most banks and credit unions offer credit card consolidation loans, and so do online lenders. You use the money to pay your cards in full, then repay the loan (usually within a few years).

The pros
- You save money on credit card interest.
- Your credit score could improve. (More on that below.)

The cons
- Once the cards are paid off, you might be tempted to use them right away.
- A loan doesn’t address the reasons for the debt, so it might happen again.

Home equity loan

This is just what it sounds like: borrowing money against your home. It’s also known as a second mortgage. Generally you can borrow up to 85% of the home’s value, after you subtract what you still owe on the mortgage.

For example:

If your home is worth $200,000 and you still owe $120,000 on it, then you might be able to borrow up to $50,000.

Here’s how the math works: $200,000 x .85 = $170,000 home value - $120,000 mortgage = $50,000 home equity loan.

The pros
- Your credit card debt is now paid in full.
- Home equity loans tend to have lower interest rates. That’s because this is a secured loan -- the collateral is your home.

The cons
- You need to have at least 15% to 20% of equity to apply, and a credit score of 620 or higher.
- Since this is a second mortgage, you have to pay closing costs.
- If you can’t make the payments, you’re in danger of losing your home.

Debt management

With debt management, you don’t take out a loan or transfer the balances. Instead, you work with a credit counseling agency to handle payments for you.

Such companies are accustomed to working with creditors and can sometimes negotiate a lower interest rate or have fees waived. This means more of your monthly payments will go toward the loan principal.

The pros
- The stress of multiple card payments is gone, because the agency deals with your creditors.
- The debt management plan includes personal finance counseling, which can help prevent future money issues.

The cons - You have to pay a monthly administrative fee.
- You’ll probably have to agree not to apply for new credit until the debt is paid in full.
- You’ll need to close the cards you include in your debt management plan, which can hurt your credit score for a while. The credit utilization ratio accounts for 30% of your FICO score.


Learn more about debt management HERE.


Balance transfer credit card

With a balance transfer, you move all existing debt onto a new credit card that offers you some incentive for doing so. Typically that’s a 0% APR introductory offer for a set amount of time (often 12 to 18 months).

You’ll usually be charged a balance transfer fee (usually about 3% of the balance). But as long as you pay the card off before the introductory period ends, you won’t pay any interest.

Here’s an example from the Discover credit card site:

  • You have $3,000 in debts at 18% interest.
  • Right now you’re paying $275 a month against the debt, which means it’ll take 12 months to pay it off and you’ll get charged $300 in interest.
  • You transfer the debts to a 0% card, paying a $90 fee.
  • If you pay the same $275 each month, the debt will still be finished in one year year. But since you’ll be charged only the transfer fee, that means you’ll save $210 in interest.

The pros
- The transfer fee can be less than the interest you’d pay on your multiple cards.
- You’ll make one payment a month instead of several.

The cons
- If you don’t have a good credit score, you probably won’t qualify for a good balance transfer deal.
- If you can’t pay it off in time, the interest rate will rise drastically – and avoiding a high interest rate was the whole point of transferring the balance.

What you should know before you consolidate credit card debt

As noted above, you might not qualify for a home equity loan or balance transfer unless you have sufficient equity and a good credit score. Debt management, on the other hand, is possible for anyone who can agree to the rules.

It might be possible to get a personal loan to consolidate credit card debt, even with a 500 credit score. However, the terms won’t be favorable – and for a debt consolidation loan, the interest rate needs to be significantly lower than the rate(s) you already have.

For example, suppose you have $5,000 in balances on three credit cards, each with a 28% interest rate. If the best credit card consolidation deal you can get is 27% then it probably wouldn’t make sense financially when you add in the loan origination fee.

The math can be confusing, so look for a credit card repayment calculator and a loan consolidation calculator to compare how much you’d save. If you’re dealing with a bank or credit union, ask the loan officer to run the numbers for you.

However, this isn’t just a question of whether you can make the payments. Credit card consolidation in and of itself is not the answer to your financial problems. You still owe the money; you’ve just kicked the can a little further down the road.

It’s crucial to figure out why you got into debt in the first place – especially since most forms of debt consolidation will zero out your credit card balances.

It could be very tempting to start using the cards again, which means adding new debt while you’re still paying off your old debt.

“You’ve got to understand what spending you were doing on those cards, what the triggers were and how you’re going to manage going forward,” says Natasha Bishop, a spokeswoman for Apprisen, a nonprofit credit counseling agency in Louisville, KY.

“If you don’t do that, then this is just going to contribute to your debt load and the cycle of debt in your life.”

How can you find a reputable company to consolidate your credit card debt?

Begin your search with local credit union(s) and banks. If possible, go there in person and ask what kind of interest rate you’d qualify for based on your credit score.

According to certified financial planner Ian Bloom, banks and credit unions often have better interest rates than online lenders.

“Whether you decide to take that offer or not, you’ll have a baseline. Whereas if you start online, you have no idea what’s a good offer vs. a bad offer,” says Bloom, of Open World Financial Life Planning in Raleigh, NC.

Armed with that knowledge, you can research online lenders and loan brokers such as Avant, Upgrade, LendingPoint and OneMain Financial. Keep in mind that there’s no guarantee a bank, credit union or online lender will work with you.

And again, a credit card consolidation might not make financial sense if the interest rate isn’t significantly lower than your current debt’s rate.

What does debt consolidation for credit cards look like?

If you decide to consolidate with a loan, it’s like applying for any personal loan:. After researching the best possible rates, you fill out an application and provide some form of ID, proof of address and a way to verify your employment. If you get the loan, you pay off the cards.

The same is true for a home equity line of credit: Do your research to find the best offer. Since it’s a second mortgage, you’ll need to have sufficient equity and a good credit score, and also a debt-to-income ratio of 43% or lower. If you’re approved, you get the money in a lump sum and pay off the cards.

To see if you qualify for a 0% balance transfer card, look for possible deals online, through your bank or credit union, or maybe even through your current card providers. If you’re approved for the card, you then work with the issuer to transfer the balances.

To enroll in a debt management plan, contact an organization like the National Foundation for Credit Counseling or the Association for Financial Counseling & Planning Education to find a nonprofit credit counselor in your area.

It’s possible that the counselor will find a way for you to pay off your debts in a timely way instead of enrolling in a debt management plan. If you can’t, then you authorize the agency to deal with your creditors and arrange to send money to the plan every month.


Related: Considering credit counseling? Read this guide.


Will debt consolidation hurt your credit score?

When you actually apply for the loan or the balance transfer card, the lender will do a hard inquiry – a type of credit check that could cause a slight drop in your credit score. However, it should rebound fairly quickly.

Over time, debt consolidation could actually improve your score, for three reasons:

1 - Paying off cards reduces your credit utilization ratio, which should be no more than 30% of available credit. For example, if you have three cards with $5,000 limits you’ve got $15,000 total credit available. If the balances on the cards add up to $10,000 then your ratio is about 66% – way too high.

(Note: Credit utilization ratio makes up 30% of your FICO score, so this is important.)

2 - If you decide to take out a credit card consolidation loan or a home equity loan, it will improve your “credit mix” – the different kinds of credit you’re handling. Instead of just having credit cards, you will also have an installment loan.

Credit mix makes up 10% of your FICO score.

3 - If you’re so overwhelmed that you sometimes forget to pay one or more of your credit cards, having one monthly payment simplifies your finances.

On-time payment makes up 35% of your FICO score.

Does debt consolidation always extend your repayment terms?

That depends.

If you don’t have a plan to finish paying off the cards on your own, then a two- to five-year debt consolidation loan might be an improvement.

Instead of paying the minimum every month for the foreseeable future, you will have a specific time frame to finish paying off the debt consolidation.

Don’t rule out the possibility of paying off the cards on your own, however.

Certified financial planner Michael Izbotsky suggests you “work it backwards”:

Add up your total debt, divide it by the number of months you hope to pay it off in, and then start looking for extra money in your budget to make additional payments.

“Some people can pay it back within six months to a year,” says Izbotsky, of the Los Angeles-based financial planning company called From Planning to Living.

It could take a little longer than a year, depending on your debt and interest rate. But you might be surprised by the results, so look for an online credit card repayment calculator.

For example, suppose you owe $5,000 at 21% interest and currently pay $300 a month against those debts. At that rate, it will take you 20 months to pay off all the cards and you’ll be charged $963 in interest.

Here’s how things would look if you boosted the monthly payment:

$340 a month: 18 months to repay, $831 total interest $375 a month: 16 months to repay, $744 total interest $400 a month: 15 months to repay, $692 total interest $425 a month: 14 months to repay, $648 total interest

In other words, you could shave up to five months off repayment, and save as much as $315 in interest.

A nonprofit credit counseling agency could help you come up with a payback plan that works. A counselor will look over your current income and expenses and help you come up with a workable household budget.

Any “extra” money the counselor finds can go against the debt.

Note: Depending on your financial situation, credit counseling can be very inexpensive or even free.

How much does it cost to consolidate credit card debt?

That depends on the type of debt consolidation you choose – and even then, the costs will vary.

Credit card consolidation loans generally carry interest rates of 4.99% to upwards of 20.89%, and “subprime” loans might range from 5.99% to 35.99%.

Balance transfer credit card fees are percentage-based. Generally it’s around 3% of the balance.

Home equity loan interest rates are variable-rate products, which means that rates change depending on the market. As of early September 2020, the average home equity loan rate was 5.96% but you will also pay closing costs (usually 2% to 5% of the loan amount).

A debt management plan with a nonprofit credit counseling agency carries both a setup fee and a monthly management fee. Expect to pay as much as $75 to get going and then up to $75 per month to pay the administrative costs of making your payments for you.

It’s usually lower than $75 per month, according to Becky House of the nonprofit American Financial Solutions in Seattle. House also notes that nonprofit credit counseling agencies won’t turn away consumers who can’t pay the full amount.

Do debt consolidation loan interest rates change?

Never take on a debt consolidation loan with an adjustable interest rate. The lender could change it at any time – and your payment rate will go up.

Any loan you take out should be fixed-rate, so that the interest rate can’t change during the life of the loan.

What is the difference between debt consolidation and debt settlement?

A debt settlement company tries to get creditors to accept a lower percentage of your debt (usually 50% to 80%), and then charge you a fee for their services. These companies often have clients stop paying their credit card bills until the companies are willing to negotiate.

This is risky, for several reasons:

  • The company can’t guarantee that the creditors will work with them. Those that won’t might hound you for payment and possibly even sue you – and if they win, they can garnish your wages or file a lien against your home.
  • Often the smaller debts get negotiated first, which means the bigger debts keep growing – especially since you aren’t making payments and interest keeps mounting.
  • Your credit score takes a beating, dropping anywhere from 65 to 125 points due to late fees and missed payments.
  • Any debt that gets forgiven is considered income and gets reported to the Internal Revenue Service. You’ll owe taxes on it the following year.

According to the federal Consumer Financial Protection Bureau, “debt settlement may well leave you deeper in debt than you were when you started.”

Debt consolidation red flags

Most red flags can be summed up in two words: “fine print.”

Loan documents can be so wordy and complicated that your eyes glaze over. But it’s essential to read them carefully, to watch for issues like:

  • High fees and/or extra fees. A loan origination fee is generally 1% to as much as 8% of the loan. Some lenders charge an application fee in addition to an origination fee. One company charged a “balance fee,” due every two weeks for the life of the loan. All this adds to the total you’ll be repaying.
  • Requests for money upfront. If a company wants cash before you’ve agreed to a loan or a debt management plan, walk away.
  • Hidden surprises. One borrower thought the loan was affordable but upon a second read-through he noticed that payment was due twice a month. Or maybe a company wants to charge a “prepayment penalty” if you’re able to pay the loan off early. Don’t skim through the document! Ask a friend to read it, too, or look for free legal help in your area.
  • Any promises to “fix” your credit report. Don’t work with any company that claims to remove negative information from your credit report. While it’s possible to contest incorrect info, no one can remove negative things that are true (such as defaulting on a credit card).

Note: Research any lender you’re interested in before you sign anything. Read customer reviews and also run the company’s name through the Better Business Bureau.

How do you keep from going back into debt after consolidation?

Maybe the debt wasn’t your fault as such, but rather the result of illness, job loss or divorce. If so, consider it a wake-up call: Time to start saving an emergency fund and also to start living below your means instead of right at them, or above them.

What’s often the case is that people simply don’t track their spending.

“Using credit cards is just so easy that some people don’t pay attention,” Izbotsky says. “It’s ‘I think I can afford this, so I’ll buy it’.”

Or maybe your debt resulted from a living situation that’s ultimately unsustainable. Suppose you want to stay in the same apartment after a divorce so your child’s life won’t be disrupted, but it’s hard to make the rent on just one income. Or maybe you bought a more expensive car than you can really afford, but you don’t want to trade it in for a cheaper model.

“There’s probably something going on that needs to be addressed,” House says.

She recommends going through bank statements to see where “money is just leaking out” due to debit card use. Some expenses – snacks, subscription boxes – not only add up fast, they also add relatively little lasting impact on a consumer’s life.

“Ask yourself, ‘Am I getting some satisfaction out of having this, or is this something I could take the money from and allocate toward getting out of debt? How could I put it to a better use?”

The bottom line

Credit card debt consolidation is not a get-out-of-jail-free card. It won’t fix underlying financial issues that caused debt. In fact, new debt might accrue – maybe even while you’re paying off the old – unless you make some changes in the way you handle your money.

However, credit card debt consolidation might be the boost you need to get control of your cash after a financial downturn or an unexpected life event such as divorce.

Run the numbers, either on your own or with help from a nonprofit counseling agency. If consolidation makes sense for you, use it to clear your debts and get on the path to financial independence.

About the author

Longtime personal finance writer Donna Freedman lives and writes in Anchorage, Alaska.

Written on September 15, 2020

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