When you’re holding significant credit card debt, it’s easy to feel like there is no way out.
According to CreditCards.com’s weekly Credit Card Rate Report, the average credit card annual percentage rate (APR) for the first week in February is a whopping 16.39%. It’s no wonder that holding credit card debt can feel like an inescapable maze when just covering interest payments seems impossible.
If you’re having trouble imagining how to pay off credit card debt, you may be an ideal candidate for debt consolidation.
Credit card debt consolidation works whether you have one card with a large balance or several cards. You will ultimately take these existing balances and refinance them into a single loan with – ideally – a much lower interest rate.
Is a debt consolidation loan the right choice for you?
Secured vs. Unsecured Debts
Consumers typically hold two types of debt: secured and unsecured. Secured debt is secured by some sort of collateral. These loans include mortgages, car loans, and any other loan types where there is something of value in place for creditors to claim should you default.
Unsecured debt is the opposite and includes things like medical bills, personal loans, and credit cards. Your creditors don’t have any claim to collateral should you default, which means they can come after you.
When you have massive unsecured debt, you want to take action as quickly as possible.
Debt Consolidation: How It Works
Let’s say your current credit card debt is $12,000 on one card and $8,000 on another, both with the national average APR of 16.39%. You’re paying over $3,500 in interest each year for that current debt above what you already owe.
So you decide to look for a debt consolidation loan and find one with an interest rate of 7.5%. Now your monthly payment has been reduced, and you’ll be paying less than half the interest you would on your regular credit card bills.
The best way to consolidate credit card debt is to identify a loan with a lower interest rate than what exists on your cards. You want to be able to pay off your balance to make a dent in your debt, while also avoiding too much interest accumulation to hinder your efforts.
Types Of Debt Consolidation Loans
You’ll have a few options when it comes to loan types for debt consolidation. If you are carrying minimal debt – $3,000 or less – you may be able to transfer that to a zero balance credit card as you’ll be able to pay it off during the promotional period.
But for debt over this amount, your best bet for credit card debt consolidation is to look at a bank or credit union loan.
- Personal Loans: If you have a good enough credit score, you can qualify for a personal loan and take out a significant enough amount to pay off your credit cards. However, because the amount you can take out and your interest rate are determined by your credit score, this may not be an option for those who have been holding debt for some time that has negatively impacted credit.
- Home Equity Loans: If you own your home, you can put it up as collateral for your new consolidation loan. These loans often come with lower interest rates because they are secured by your property. However, this puts the future of your home in jeopardy if you’re not responsible with your consolidation loan repayments.
- Unsecured Debt Consolidation Loans: You take out this loan as you would any other, and its purpose is to help you consolidate unsecured debts in one place. The benefit of a consolidation loan is that you do not have to risk any of your assets as collateral; the downside is you may end up paying higher interest rates than other loan types. Keep an eye on timelines as you can end up paying more overall with an extended repayment period.
The Benefits Of A Debt Consolidation Loan
There are several ways to deal with unsecured debt from credit cards. Of these, debt consolidation can help you gain control over what you owe, and what you pay. The greatest benefits of debt consolidation loans are:
Only pay one lender: Instead of paying all of your creditors at different times, when you consolidate your debt, you just need to pay the one loan.
Reduce your late payments: When you’re only paying one bill each month, you’re reducing the risk of late or missed payments.
Lower interest rates: The goal of debt consolidation is to refinance your existing debt into a new loan with a lower interest rate.
Lower monthly payments: Along with a lower interest rate, your debt consolidation loan will give you lower monthly payments spread over a greater amount of time.
Potential credit score boosts: If you’re responsible and on-time with your payments, a consolidation loan can raise your credit score as you’re no longer having trouble paying multiple creditors. However, it can also have adverse effects on your score should you start adding additional debt.
What You Need To Know Before Getting A Debt Consolidation Loan
You can’t make any financial decision lightly, and the same goes with finding the right debt consolidation loan options. Debt consolidation loans do have some drawbacks, but if you prepare for them, you can help reduce the risk.
Drawback #1: Longer payment periods: Your debt consolidation loan will likely come with a more extended payment period, as your balances are spread over time to help reduce your monthly payment. That means you’ll be holding debt longer, and you’ll need to be responsible with spending and budgeting so that you don’t end up accumulating more on top.
Drawback #2: Temptation to spend: You’ve cleared out those balances on your credit cards, so now you can buy that big-ticket item you’ve been looking for, right? Wrong. When you zero out your credit cards balances, leave them there until you look for a debt consolidation loan. Your overall goal is debt reduction, not more money to spend now.
Drawback #3: You’ll need to qualify: The goal of your consolidation loan is to get rid of the debts that are causing you to have trouble moving forward financially. If you’ve had a history of late payments, carry high balances, and your debt-to-credit-limit ratio is too high, your credit has probably suffered. Because a debt consolidation loan is like any other loan, your credit will be a primary factor in deciding your interest rates and terms. Poor credit may mean that you’re not getting a loan with a low enough rate that makes it worthwhile.
If you’re committed to reducing your debt, it’s necessary to take steps to improve your entire financial outlook. Get updated tips that are sure to help sent right to your inbox; sign up for our newsletter now!