What do I need to know about consolidating my credit card debt?
There are several ways to consolidate or combine your debt into one payment, but there are a number of important things to consider before moving forward with a debt consolidation loan.
Debt consolidation means that your various debts–whether credit card bills or other loan payments–are rolled into one loan or monthly payment. If you have multiple credit card accounts or loans, consolidation may be a way to simplify or lower payments. But a debt consolidation loan does not erase your debt, and you may end up paying more in the end.
Here are different types of debt consolidation and what you need to consider before taking out a loan.
Before taking out a consolidation loan
Get free support from a nonprofit credit counselor. Credit counseling organizations can advise you on how to manage your money and pay off your debts, so you can better avoid issues in the future.
Get to the bottom of why you’re in debt. It’s important to understand why you are in debt. If you have accrued a lot of debt because you’re spending more than you’re earning, a debt consolidation loan probably won’t help you get out of debt unless you reduce your spending or increase your income.
Make a budget. Figure out if you can pay off your existing debt by adjusting the way you spend for a period of time.
Try reaching out to your individual creditors to see if they will agree to lower your payments. Some creditors might be willing to accept lower minimum monthly payments, waive certain fees, reduce your interest rate, or change your monthly due date to match up better to when you get paid, to help you pay back your debt.
Types of consolidation loans
If you’re considering ways to consolidate debt, there are several different types of products that allow you to do this, but for each, there are important things to keep in mind before moving forward.
Credit card balance transfers
Many credit card companies offer zero-percent or low-interest balance transfers to invite you to consolidate your credit card debt onto one card.
What you should know:
The promotional interest rate for most balance transfers lasts for a limited time. After that, the interest rate on your new credit card may rise, increasing your payment amount. You’ll probably have to pay a “balance transfer fee.” The fee is usually a certain percentage of the amount you transfer or a fixed amount, whichever is more.
There are some risks to consider. If you use the same credit card to make new purchases, you won’t get a grace period for those purchases and you will have to pay interest until you pay the entire balance off in full, including the transferred balance.
If you’re more than 60 days late on a payment, the credit card company can increase your interest rate on all balances, including the transferred balance.
Debt consolidation loan
Banks, credit unions, and installment loan lenders may offer debt consolidation loans. These loans convert many of your debts into one loan payment, simplifying how many payments you have to make. These offers also might be for lower interest rates than what you’re currently paying.
What you should know:
Many of the low interest rates for debt consolidation loans may be “teaser rates” that only last for a certain time. After that, your lender may increase the rate you have to pay.
Although your monthly payment might be lower, it may be because you’re paying over a longer time. This could mean that you will pay a lot more overall, including fees or costs for the loan that you would not have had to pay if you continued making your other payments without consolidation.
Tip: If you consider a debt consolidation loan, compare loan terms and interest rates to see how much interest and fees you’ll pay overall. This can help you pick the loan that saves you the most money.
Home equity loan
With a home equity loan, you’re borrowing against the equity in your home. When used for debt consolidation, you use the loan to pay off existing creditors first, and then you have to pay back the home equity loan.
What you should know:
Home equity loans may offer lower interest rates than other types of loans. But, using a home equity loan to consolidate credit card debt is risky. If you don’t pay back the loan, you could lose your home in foreclosure. You may also have to pay closing costs with a home equity loan. Closing costs can be hundreds or thousands of dollars.
Take note, using your equity for a loan could put you at risk for being “underwater” on your home if your home value falls. This could make it harder to sell or refinance.
If you use your home equity to consolidate your credit card debt, it may not be available in an emergency or for expenses like home renovations or repairs.
Other factors to consider before taking out a debt consolidation loan
Taking on new debt to pay off old debt may just be kicking the can down the road. Many people don’t succeed in paying off their debt by taking on more debt unless they lower their spending.
The loans you take out to consolidate your debt may end up costing you more in fees and rising interest rates than if you had just paid your previous debt payments. And, if problems with debt have affected your credit score, you probably won’t be able to get low interest rates on the balance transfer, debt consolidation loan, or home equity loan.
Warning: Beware of debt consolidation promotions that seem too good to be true. Many companies that advertise consolidation services may actually be debt settlement companies, which often charge up-front fees in return for promising to settle your debts. They may also convince you to stop paying your debts and instead transfer money into a special account. Using these services can be risky.